Selecting a Legal Structure for your Business: LLC, LLP, S-Corp …?

What is a legal structure ?  A legal structure (sometimes referred to as an entity or business structure) is the legal formation of a business entity allowing you to operate as a business separate and distinct form yourself and providing you with additional protections and benefits.  There are a number of things to take into consideration when choosing the legal structure that is right for your business.  This may require not only enlisting the expertise of an experienced business attorney, but consulting with your accountant as well.

Major issues for consideration include:

  • Taxation Concerns
  • Liability Protection
  • Expense
  • Risk
  • Control
  • Corporate Formalities
  • Continuity of Existence
  • Transferability
  • Management Organization
  • Method of Capitalization
  • Interested Parties
  • Ownership Interest

There are a number of different legal structure under which you can form:

  • Sole Proprietorship: A sole proprietorship is a single member entity providing the least amount of maintenance, but also the lowest level of protection.  The individual has unlimited personal liability on behalf of the entity.  The entity and the individual are one and the same.  Formation merely requires the owner to hold themselves out as doing business as the entity. (Some states and towns do require DBA registration).  Income or loss of the business is accounted for through the individual’s tax return via pass-through taxation and the owner must pay self-employment taxes through one’s personal income tax return.
  • General Partnership (GP):  Similar to a sole proprietorship a general partnership is formed when two or more individuals hold themselves out to be in business.  There is no legal separation between the owners and the business.  There are no legal formation formalities to follow.  BEWARE you may have unknowingly created a general partnership and could be held personally liable for the actions of your partner.  It is highly advisable to at least have a Partnership Agreement drafted to protect each of your interests.  Taxes are paid through the owners’ personal tax returns and the partnership files an Informational Income Tax Return Form 1065 with the IRS.
  • Limited Partnership (LP):  A limited partnership is a business relationship that consists of two or more people, with at least one general partner who has unlimited general liability (the general partner can also be a separate entity in and of themselves) and one limited partner whose liability is limited to the amount of their investment.  These relationships are often formed as entities are attempting to raise capital.  A limited partnership is formed under statute and filed with the state.  Taxation depends on the organization of the entity.
  • Limited Liability Partnership (LLP):  Limited liability partnerships are similar to the limited partnership except all of the members enjoy the limited liability protection and the entity is taxed via pass-through taxation of the partnership.
  • Limited Liability Company (LLC):  LLCs are a relatively new form of business structure in the United States but are rapidly becoming the preferred legal structure of businesses big and small alike.  An LLC is created by filing Articles/Certificate of Organization with the state.  It provides the limited liability protection of a corporation, without the hassle of corporate formalities, and also allows for pass-through partnership taxation.
  • Corporation (C Corporation):  Corporations typically have four identifying characteristics: limited liability, continuity of life, centralization of management, and free transferability of ownership interests.  A corporation is the most sophisticated form of business organization and is commonly used by large companies.  A corporation is a body of persons granted a charter legally recognizing them as a separate entity with its own rights, privileges, and liabilities separate from its members.  A corporation is formed by filing Articles of Incorporation with the state and issuing stock to shareholders.  Corporations must follow a number of corporate formalities.  Corporations are taxed at both the corporate level and on an individual level with regard to dividends.
  • S-Corporation (S-Corp):  As the name implies an S-corporation (“s” standing for small business) is a corporation that is organized under subchapter S of the Internal Revenue Code.  It is formed by making a subchapter S election when filing the corporation and filing IRS Form 2553.  The S-Corp election effects the taxation issues and the income, gains, losses and deductions are passed through in proportion to one’s ownership shares.  In order to qualify for an S-Corp election the business may not have more than 100 shareholders, they must be individuals not entities (with some limited exceptions), it must be a domestic corporation, shareholders may not be non-resident aliens, and the S-Corp may not have more than one class of stock.  The deadlines for S-Corp elections are tight and strict.  You must file your election within 75 days or will be taxed as a C-Corp for the first year.
  • Professional Corporation (PC): A professional corporation is a corporate structures for professional service providers working in industries that have more stringent legal regulations (ie doctors, lawyers, accountants..).  A PC does not usually provide the owners the same limited liability as the other corporate structures.  The PC should protect one individual from the malpractice liability of another, but not from their own malpractice liability.  The PC can only perform one service and once created only professionals of the specific industry can share in ownership of the corporation.
  • Benefit Corporation (B Corp):  Some states have adopted the benefit corporation which incorporates aspects of the non-profit and for-profit legal structures.  The key distinguishing factors are under the B-corp there is: (1) broadened fiduciary discretion for directors and officers; (2) formal oversight of public benefit mission; and (3) increased accountability.
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