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So you are thinking about creating a new business, or know that you want to set up a new commercial enterprise, but aren’t certain of the best legal structure for your business. Should you set up a partnership or a limited liability company, or would a corporation be best. This blog post discusses some of the more familiar business entities, and helps you identify their advantages and disadvantages. Before you take steps to set up your new business, you want to work with an experienced business lawyer.
The principal issues that you need to consider when setting up a new business are:
- The extent to which you will be personally liable for any obligations of the business
- The tax implications
- Ease and cost of set-up and ease and cost of entity governance
Partnerships — A general partnership requires no formal state filing. You will want to establish and execute a partnership agreement, setting forth the rights and responsibilities of all parties. All income earned through a partnership is considered personal income (pass through income), and is taxed at your personal income tax rate. In a general partnership you are liable for all obligations of the partnership, even those that were incurred by other partners, and the liability can extend to your personal assets. In a limited partnership, you may only be liable up to the amount of your investment. A limited partnership requires a filing with the State to create.
Corporations — Though a corporation has more formalities and requires that you file articles of incorporation with the state, the corporate form also minimizes your liability. When you own shares in a corporation, your liability is generally limited to the amount you invested to purchase the shares, unless it can be shown that the corporation was set up as an undercapitalized or underinsured sham to shield you from liability. You can set up a Subchapter C or a Subchapter S corporation. A C corporation is subject to a corporate tax, and any dividends it pays are subject to personal income tax (double taxation). Earnings may be retained. An S corporation does not pay any corporate tax, and all distributions are considered personal income.
Limited Liability Companies (LLCs) — An LLC must be created by a filing with the State. It is intended to provide limitation of liability to its owners similar to that provided to corporate shareholders. An LLC may have one or may owners (members). Governance is as specified in the Operating Agreement and may be more like a corporation, or more like a partnership. LLC’s may elect to be taxed either as a “pass-through” entity, a Sub S or Sub C Corporation.
