As a business lawyer in Little Rock, I enjoy and appreciate the opportunity to consult with you as you make the important decision of choosing the most advantageous type of business entity under which to operate your new venture. Whether you are forming a new company, dissolving an old company, buying or selling a business through its assets or stock, I can navigate you through the nuances of reaching your goals. A summary of some of the major considerations in selecting any of the entities that are provided under business law are as follows, but certainly spend some time with me to discuss your needs:
LLC
LLCs are increasingly popular, because they combine the best legal and tax characteristics of corporations and partnerships, while avoiding many of their disadvantages. Specifically, an LLC can offer limited liability protection to all its owners (referred to as "members") while being classified as a partnership for federal income tax purposes.
Single-Member LLC
Single-member LLCs are now available in all but a few states. The unique attribute of single-member LLCs is that they are ignored for federal tax purposes. Thus, when a single-member LLC owned by an individual is used to conduct a trade or business activity, it is treated as a sole proprietorship for federal income tax purposes. Accordingly, the owner reports the business income and deductions on Schedule C and computes the SE tax on Schedule SE. Both Schedules are filed with the owner's Form 1040. Similarly, when a single-member LLC owned by an individual is used to hold rental real estate, the owner files Schedule E with his or her Form 1040 to report the income and deductions from the rental activity. Even though the single-member LLC is "invisible" for federal tax purposes, it still exists for state law purposes and thus protects the owner's personal assets from most business-related liabilities. Generally, the single-member LLC is the preferred choice when pass-through taxation is desired for a single-owner business. The only other pass-through alternative for a single-owner business is the S corporation, which has strict qualification rules, as explained earlier. Because it offers liability protection advantages, the single-member LLC is almost always preferred to sole proprietorship status. The only exceptions would be when single-member LLCs are treated disadvantageously for under state income tax rules or when LLC status is unavailable under state law or professional standards. For example, Texas single-member LLCs must pay the state's corporate franchise tax, while sole proprietors are exempt.
S Corps & C Corps
Legally, S corporations and C corporations are identical. Arguably, corporations offer the greatest certainty in terms of protecting the personal assets of owners from the risks of the business. A corporation is treated as a legal entity separate and distinct from its shareholders. Therefore, the corporation owns its own assets and is liable for its own debts. As a result, the personal assets of shareholders (including shareholder-employees) generally are beyond the reach of corporate creditors. Shareholders generally remain exposed to liabilities resulting from their own tortious acts and their own professional errors and omissions. Shareholders may be required on occasion to personally guarantee certain of the corporation's debts as a condition of obtaining financing or for other reasons. Shareholders are personally obligated with respect to corporate debts that are specifically guaranteed.
The principal advantage of C corporations is their proven ability to protect owners from liabilities related to the business. As discussed earlier, the liability-limiting attributes of C and S corporations are identical.
Qualified Small Business Corporations (QSBCs) may be useful if a C corporation meets the definition of a QSBC, shareholders (other than C corporations) potentially are eligible to exclude from taxation up to 50% of their gains on sale of the corporation's stock. In addition, shareholders may be able to roll over gains tax-free by investing in new QSBC stock issued by a different company. A number of rules must be met for a corporation to qualify for QSBC status, and shareholders must own their stock for more than five years to benefit from the gain exclusion provision and for more than six months to take advantage of the gain rollover rule. QSBCs present a real alternative to pass-though entities in cases where corporations will qualify for QSBC status.
LLP
LLPs are a relatively new type of entity that can be particularly useful for the operation of professional practices. LLPs are formed and operated pursuant to state LLP statutes.
The partners of a general partnership are personally liable (without limitation) for all debts and obligations of the partnership. The liability of general partners is "joint and several" in nature. This means that any one of the general partners can be forced to make good on all partnership liabilities. That partner may be able to seek reimbursement from the partnership for payments in excess of his or her share of liabilities. But this depends on the ability of the other partners to contribute funds to allow the partnership to make such reimbursement. Note also that general partners are jointly and severally liable for partnership liabilities related to tortious acts and professional errors and omissions of the other general partners and the partnership's employees. In addition, general partners are personally liable for their own tortious acts, errors, and omissions. Finally, each general partner usually has the power to act as an agent of the partnership and enter into contracts that are legally binding on the partnership (and ultimately on the other partners). For example, a partner can enter into a lease arrangement that is legally binding on the partnership. It is critical, therefore, if a general partnership is to be formed, for co-owners to have high levels of trust in each other.
A limited partnership is a separate legal entity (apart from its limited partners) that owns its assets and is liable for its debts. Therefore, the personal assets of the limited partners generally are beyond the reach of partnership creditors. This is the nontax selling point of limited partnerships. Limited partners are, however, still personally responsible for partnership liabilities resulting from their own tortious acts. The key negative factor associated with limited partnerships is that they must have at least one general partner with unlimited personal exposure to partnership liabilities. Usually this problem can be addressed by forming a corporate general partner. This is often an S corporation. With this strategy, the amount the general partner can lose is effectively limited to the value of the assets held by the corporation. Another potentially significant negative factor is that limited partners can lose their limited liability protection by becoming too actively involved in managing the limited partnership. As a result, limited partnerships may be unsuitable for activities where all partners are heavily involved in the business (for example, professional practices). The key tax advantage of limited partnerships is that they can be treated as partnerships for federal income tax purposes.