Every business has some or other financial implications during its tenure. The appropriate legal form of business depends on the degree or severity of these implications. Sole proprietorship or partnership is easy to form and operate but the personal risk of the business owner (s) in operating these forms is unlimited. When the transactions and risks involved in a business is considerable, it is necessary to choose a form that provides protection from unlimited personal liability. Corporations and Limited Liability Companies offer the personal liability protection to its business owners.
If the primary objective of the business form is personal liability protection, LLC form will serve the purpose. Forming LLC or Corporation needs certain legal formalities to be complied with. However, corporations are high maintenance business forms. Unless the business owners do not foresee considerable growth or intend to take the business to the public, forming and maintaining a corporation is not worth the hassle. Another plus for forming LLC is in LLC Taxation. Corporations have to file an individual tax return as a legal entity or ‘person’ and pay state and federal taxes directly. Again, when the profits are distributed as dividend among the shareholders, they have to declare it as personal income and pay tax. Sort of double taxation. The members, as the business owners of an LLC is called, can elect to be taxed as sole proprietorship, partnership or even a corporation, whichever is most beneficial to them.
How to LLC formation, the state laws regulate the formation and operation of LLCs. Each state has different rules and procedures for incorporation or organization of an LLC. Refer to your state LLC regulations to understand the requirements for forming and operating LLC. In all states one basic requirement is filing the Articles of organization. The nomenclature may change in each state but the purpose is the same. An available valid name has to be chosen for your LLC. Then file the articles of organization in that name and provide all the information in the articles as required by the state. You need a person or entity with a local address to act as your registered agent and that person’s written consent to act so must be provided. Some states stipulate an Operating Agreement duly executed and signed by the proposed members as a part of the business registration process. Even otherwise, an operating agreement is beneficial to the business in many ways. It will provide clarity to business’s operational and organizational structure and a separate identity from that of the members. A publication of the intent to form the LLC may be required in some states.
Partnership is a legal form of business which requires few legal formalities to form and operate. Merely the intention to jointly operate a business by two or more persons is enough to form a partnership. State laws govern the formation, operation and dissolution of partnerships. All states have adopted the Uniform Partnership Law but with a few variances in each state. If a question arises as to the legal existence of a partnership, the law looks for certain aspects of the business such a:
1) the intention to jointly operate
2) sharing of profits or losses
3) joint control and ownership of property.
In a partnership, unless expressly stated otherwise all partners have equal rights and responsibilities. All partners have equal right to a share in profits and are personally and jointly responsible for all the activities of the partnership at its agents. However, the rights and responsibilities of each partner can be specified through a partnership agreement. The partners can state the capital contribution of each partner, the resultant share in profits, operational responsibility of each partner, any special consideration payable to a partner for a business expertise that partner contributes to the business and such other terms and conditions of the partnership business. An important point to note here is that regardless of any stipulations in a written partnership agreement, all partners are still personally liable to the business debts and obligations without any limit. If a claim arises out of the business and one of the partners is personally not able to pay, the other partner or partners have to settle the claim with their personal assets and then sue the defaulting partner to compensate.
There some forms of partnership that limits the personal liability of partners such as a limited partnership or limited liability partnership. Despite the similarity in name, both forms are distinct in its nature. A limited partnership has a general partner and one or more limited partners. Only the general partner is active in business operations and has complete decision making power and is personally responsible for the partnership’s activities. The limited partners have a share of business but have no active involvement in the operations. Generally this form is used in a family limited partnership to protect joint family property. The dominant member of the family acts as the general partner and other members as limited partners. In a Limited Liability Partnership, all partners have limited personal liability to the partnership activities. This form is used in professions where misconduct or negligence of one partner may affect the whole partnership and to protect other partner or partners for being personal responsible for such misconduct or negligence.
For an aspiring entrepreneur the path towards growth is to attract capital for business. Investors generally look for a few qualities in the business they want to invest. For any investor, the return on investment is the foremost criterion. The returns can be in the form of regular cash flow or appreciation in the value of investment. For attracting such investors, the best form of business is a corporation. The advantage of a corporation is that the shares are freely transferable. The investor can invest or divest in a corporation and there are very few formalities to be observed. Another advantage of a corporation is the personal liability protection it offers to the shareholder. Due to these advantages, investors are readily willing to invest in corporations and hence the ease in attracting capital for expansion.
The state laws govern the incorporation of your small business. The incorporation rules vary in each state. The key procedure for incorporating a business is to file a certificate of incorporation with the state and pay a filing fee. In some states the certificate of incorporation is also called the articles of incorporation. The ownership in a corporation is structured as units of stock or shares, which is subscribed to and promised to pay for by the shareholders. The corporations can be of two types namely an S Corp or a C Corp. The basic legal structures of both forms are similar. The main differences are the share holding and taxation. Shares in an S Corp are restricted to natural US citizens and limited to a maximum of 100. There are no such restrictions in a C Corp. C Corporations are subject to corporate taxation where as the S Corporation advantage is that the profits are passed through to the share holders and taxed as their personal income.
Limited Liability Companies also offer personal liability protection to its owners who are called members. The advantage in LLC Vs. Corporation is that in the eyes of the general public, corporations are ‘perpetual’. LLCs are considered to be bound to the life of its members. One advantage in LLC is that procedure for taxation can be decided by the members and they can elect to be taxed as a partnership or a corporation. The advantage in LLC Vs. S Corp is that LLCs are relatively easy to form and less cumbersome to operate. Members of an LLC can elect to be taxed as an S Corporation and avoid the double taxation of a C Corporation.
Incorporation is no more a mystery and the domain of lawyers. The common man is very well equipped to handle matters such as incorporation or organization of a business. Thanks to our public friendly state administrations. All states have provided online resources for business registrations with clear instructions on how to proceed. You may contact the state agency handling business registrations over phone or in person also to clear you doubts. You may check with your state agency whether corporate seals are legally binding in your state.
A legal business structure is imperative in operating a business in any of the states. Some forms of business do not involve many legal or statutory formalities in formation and its operations. Sole Proprietorships and General Partnerships can be formed by simple intent of the principal(s). However you will need to obtain all the obligatory permits and licences to operate the business. Forming a Limited Liability Company or a Corporation entails formal procedures. The organisation of LLC or the incorporation of a corporation is governed by state statute. These rules and regulations vary in each state. For forming a LLC you have to select a name and file an Articles of Organization with the state agency handling business registrations and pay a filing fee. Some states have a few more requirements for forming LLC such as filing an LLC Operating Agreement and publication of the intent to form LLC.
Forming a corporation involves lengthier procedures than forming a LLC. A corporation has a separate legal entity from that of its business owners, formally termed as share holders. The corporation is constituted by units of stocks or shares which each share holder subscribes to and promise to pay for. The basic charter for operating business as a corporation is its Articles of Incorporation. The promoters or incorporators have to provide all critical information on the purpose of formation and the organizational structure as required by the state. There are two types of corporations, C Corp and S Corp.
Taxation formalities in each of the business form vary. The sole proprietorship is considered as having no individual existence or a ‘disregarded entity’ and the business owner files business tax returns along with personal returns. Partnerships have a similar system where the profits or loss from business is declared proportionately through partner’s personal tax filing. Partnership has to file an information return separately. LLCs or S Corps has a pass through taxation system as that of a partnership. Corporations are taxed directly and have to file separate tax and information returns.
A Series Limited Liability Company is a special form of business structure that provides limited liability protection to each individual constituent of an LLC. To elaborate, in a series LLC, each of the (multiple) series of companies is protected from the liabilities of the others. It is something akin to a corporation with subsidiaries. Generally series LLCs are formed to protect real estate investments. Each separate investment is constituted as an LLC and brought under a single entity. By doing this the specific LLC in the series is liable only to claims arising out of its own business. In this manner each investment is protected from the liabilities of other LLC’s in the series, essentially liability of one LLC does not cross over to the other series. The advantage of a series LLC form is that the legal and statutory obligations and administrative procedures can be performed as a single entity. There are limitations to this single entity filing though. If any of the series constituents has a member who is not a member of the founding LLC, it has to file returns and pay fees as a separate LLC. There are some tax benefits also in forming a series LLC. One among them is that if one of the series is using property of another for business purposes and paying rent, sales tax on the rent may not be applicable.
How to form a LLC series depend on the state statute where you wish to register your series LLC. Basically the requirements are almost the same as forming a normal LLC. An Articles or Certificate of Organization has to be filed and due fees paid. Series LLC should have a Limited Liability Company Agreement like that of the Operating Agreement in a normal LLC. Addition of new series or deletion of an existing series is uncomplicated. An amendment to the agreement would suffice. Each constituent of the series LLC should have a distinguishing mark that separates it from others. For example, XYZ LLC Series A or XYZ LLC Series B. Keeping the business of each LLC seperate in the series is imperative. You must maintain separate books of accounts, bank accounts and other legal documents and transactions to get the limited liability protection for each LLC. Ensure that all assets and contracts distinctively state the name of the series it belongs to. The transactions between the series must be in a comparable uncontrolled price method or a fair market price method and should be properly recorded.
Limited Liability Partnership is a legal business form wherein the personal liability of all partners is limited for any act of the partnership whether in tort or contract unlike that of a general partnership where all partners equally and individually liable for the partnership’s obligations. Even if the general partnership is governed by a partnership agreement that specifies differential partnership interest, all partners are equally responsible and liable for the partnership’s business activities and debts.
Although all the states have adopted the Revised Uniform Partnership act, there are variances in the statute as passed by various states. Some states give the limited liability shield to partners only in negligence cases and not in contract or tort. Limited Liability partnerships are preferred by professional organizations as it provides the limited liability feature of a corporation and flexibility of operations as in a partnership. In a limited liability partnership, claims due to negligence, misconduct or breach of contract by one partner does not affect the personal assets of other partners. This protection does not extend to the partner whose misconduct or negligence instigated the claim. In some states only professional organisations such as lawyers or accountants can form limited liability partnership.
The framework of Partnership laws in each state is based on the Revised Uniform Partnership Act which all states have adopted. Formation of Limited Liability partnership may differ from state to state. In all states a certificate of registration is required to register a limited liability partnership. The application for registration of LLP must disclose the names and addresses of all partners, the Doing Business As name and the principle place of business, purpose of the LLP etc among other things. Some states stipulate that the LLP has a minimum capital infusion during formation and buy enough insurance coverage to face any eventualities.
You can convert your existing general partnership or limited partnership to limited liability partnership by filing a change request with the state. If you have an existing partnership agreement, no major changes are required to it unless you want to change existing partner’s rights and responsibilities. You have to add the words ‘Registered Limited Liability Partnership’ or ‘Limited Liability Partnership’ or an abbreviation such as LLP or RLLP to the name of your firm. You have to pay a filing fee to register the LLP with the state. This again varies from state to state. Some states charge filing fees according to the number of partners.
