In today's Freedom Friday blog and email newsletter, I want to re-visit some information and some questions I routinely get. I've blogged about this topic before, at least 2-3 times a year, but due to the frequency of questions I get about this topic, I wanted to address it again this week. In today's Freedom Friday blog and email newsletter, I'm talking about how to choose a business entity.
Most clients that come to me with questions about a business entity already have an idea of what they're looking for. There are certain options they are considering, and they want an attorney to help them decide the best option for them. For example, I get several calls throughout each and every year asking about a PLLC versus an LLC, and I have a blog article out there on that topic that is one of the most popular. The other topic that I get asked about is LLC versus S corporation, or about the S corporation issue, in general. Just an FYI --- an S corporation is a tax election, not a business entity. It's appropriate for some small businesses, and it's not needed for others. However, in this week's Freedom Friday blog and email newsletter, I want to take a step back from all of those discussions and present the big picture of the four (4) business entities you can choose for your small business.
The first basic business entity you can choose for your small business is a sole proprietorship, and this is the default option if it is just you (with no partners), and you don't do anything else. There are no documents to fill out and file with the Oklahoma Secretary of State, although you might choose to do a DBA, which is not required. However, if you choose this option, there are significant disadvantages, because you accept personal responsibility and liability for any lawsuit filed against your business, or any debt undertaken by you for your business. This can be very dangerous because a creditor can get a judgment against you personally and come after all your personal assets, like your house, your bank account(s), etc. You can hire employees as a sole proprietorship, but if you add an additional co-owner, you become a partnership.
The second basic business entity you can choose for your small business is a partnership, and this is the default option if you are going into business with at least one other person (i.e., a partner), but you don't do anything else. There are two types of partnerships. The first kind of partnership is called a general partnership. In a general partnership, all the partners are jointly and severally liable for the business; this includes lawsuits, judgments, debts, etc. Again, all that's required is for two or more “partners” to co-own a business.
The second kind of partnership is called a limited partnership. In a limited partnership, one partner is identified as a “general partner,” and the remaining partners are “limited partners”. The general partner has unlimited liability who assumes full liability for all the debts, judgments, liabilities, etc., of the business. However, the limited partners have limited liability, which means they are not responsible for debts or judgments of the business, but this also means the limited partners don't have the authority to actively manage the business, either. They are passive investors, similar to shareholders in a corporation, as discussed next.
The third basic business entity you can choose is a corporation, and again, the default corporate structure is called a “C corporation”. As such, a corporation is a separate legal entity from its ownership (the shareholders). Shareholders usually take a passive approach to management (unless the corporation is “closely held”) but make an investment in the company financially. There are different types of shareholders, including “common” and “preferred” and the bylaws of a corporation will explain the difference between the two; a common distinction is voting. The biggest disadvantage to a corporation is double taxation. Not only is the corporation taxed on its revenue, but shareholders are also taxed on their dividends. In addition, a corporation is required to maintain certain formalities, including having annual meetings and documenting their meetings through “minutes” of the meetings. Remember, an “S corporation” is not a corporate entity, but a tax election with the IRS, and that's a subject for another day.
Limited Liability Company (LLC)
Lastly, the fourth basic business entity you can choose is the limited liability company, or LLC. An LLC is probably the best and most common structure to choose from and gives you the greatest flexibility. Every owner of an LLC (owners are called “members”) has limited liability, but unless the LLC elects to be treated as an S corporation with the IRS, a single-member LLC will be treated as a sole proprietorship for tax purposes, and a multi-member LLC will be treated as a partnership for tax purposes. If you don't want that tax treatment, talk with your CPA or tax professional, and consider electing to be treated as an S corporation with the IRS. While an LLC is not required to maintain the formalities of a corporation, it should have an “operating agreement” which is the same as what bylaws are for a corporation. The more members you have in the LLC, the more extensive your operating agreement should be in outlining the rights and responsibilities of the members (owners) of the LLC.
Thinking about starting a small business? Or maybe your small business is having issues with contracts, leases, business partners, collection issues, or experiencing other barriers to growth? Please contact me at [email protected] to schedule a FREE strategy session.
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