Choice of Business Entities: Corporation, Partnership, LLC (or something else)?
Updated: Jun 1
Great ideas and opportunities usually require the right type of business entity to carry out the new venture, hold property or assets, or manage some aspect of the operation. The answer can be very sim
ple or complex depending on the type of venture, the persons involved and how they want to define their business relationship, the types of assets the business may hold and desired tax treatment. Coming up with a plan is essential to the success of your budding enterprise and will imbue you with confidence as your plans move forward. In the most basic terms, each offers liability protections and tax consequences. For some of the more nuanced differences, consult a competent business attorney or estate planning attorney.
Most of the liability-limiting laws, rights, responsibilities, and requirements to create and maintain an entity are prescribed by State law. Florida law recognizes four kinds of business entities: (1) sole proprietorships; (2) corporations; (3) partnerships; and (4) limited liability companies https://dos.myflorida.com/sunbiz/start-business/corporate-structure/.
The key characteristic of the sole proprietorship, as the name implies, is that it is owned by one individual. This is the simplest type of entity to elect because in order to create a sole proprietorship, you do not need to file anything—it is an unincorporated business. All you need to do is operate your business unless you want to use a name different than your legal name in which case you must register a fictitious name with the Division of Corporations.
There are several downsides to sole proprietorships: no distinction between the owner and business for tax purposes or for liability purposes. Accordingly, sole proprietorships are passthrough entities, which avoids the issue of double taxation. The owner simply reports the business income and expenses on Schedule C of their Form 1040. Lack of liability protections means that creditors can go after you for the debts of the business. It also means that anyone who is injured as a result of your business operations or by an employee in the course of conducting your business may sue you personally.
One of the principal reasons entities are formed is to avoid the consequences associated with operating sole proprietorships.
Corporations (including professional associations, P.A.)
Corporations, unlike sole proprietorships, have a distinct existence from that of the owners (shareholders) and operators allowing them to independently enter into contracts, purchase and own property, and pay taxes—that is the liability protection portion. Liability protection is maintained as long as this fiction of separateness is maintained by not comingling personal funds and assets with those of the corporation, observing the corporate formalities such as the yearly meeting and adopting resolutions for major decisions, and not misusing the corporate form by doing such things as defrauding creditors.
Corporations are generally considered the most expensive and difficult to create and administer. Under Florida law, a corporation must have an organizational meeting, issue shares, designate a par value for these shares, have at least one yearly meeting, and designate directors and officers. Corporations theoretically exist in perpetuity, but you must file the annual report with the Division of Corporations, or your corporation will be administratively dissolved. Despite the relative difficulty in creating and maintaining a corporation, having shares to sell can facilitate in raising capital.
The corporate bylaws dictate how the corporation should be operated, the rights and responsibilities of directors, officers, shareholders, rules and regulations, and various events in the life of the corporation.
In contrast with sole proprietorships, corporations’ profits are taxed on the entity level (by filing Form 1120) and shareholders are taxed on income and distributions paid by the corporation, which are reported on their returns. A corporation with less than 100 shareholders can elect for S-Corp status so that the profits and losses pass through the entity to the shareholders while still maintaining the liability-limiting benefits of the corporation.
Unlike sole proprietorships and corporations, a partnership cannot be owned by a single individual—a partnership must be co-owned by two or more persons or entities. Each of the co-owners contributes capital, property or talents to the partnership and capital accounts are maintained for each partner. There are general partnerships and limited partnerships. In a general partnership, each partner participates in the management of the partnership. That means that each partner is liable for the actions and debts of the partnership. A limited partnership, not to be confused with a limited liability partnership, is one in which the limited partners do not participate in the operation of the partnership. The limited partners—so long as they do not participate in the management of the partnership—have limited liability while the general partners in a limited partnership may still be held liable for the partnership’s obligations.
The Partnership Agreement dictates the rights and responsibilities of the partners in addition to some of the ways the partnership will be operated.
Although partnerships do not have the liability-limiting benefits of corporations, they are not subject to taxation on the entity level. Partners receive a Schedule K-1 (Form 1065) from the partnership. This schedule provides information on how to report income, expenses, credits allocable to each partner on his or her individual returns.
Limited Liability Companies
Limited liability companies are hybrid entitles with some features of the corporation—such as limited liability—and some of a partnership—mainly that it is not taxed on the entity level. Managing a limited liability company (LLC) is simpler than managing a corporation. For example, there is no need to have regular stockholder meetings, yearly meetings, and it is not necessary to comply with the other corporate formalities. Additionally, there is a lot of flexibility and adaptability with the LLC. Unlike partnerships, LLCs can be owned by one individual or entity. The owners of the LLC are referred to as members and operated by managers, which can also be members
The Operating Agreement is the LLC document that equivalent to the corporate bylaws. Florida law does not require the LLC to have an operating agreement but most banks and creditors require the LLC to have one so that they can assess any additional risks in conducting business with the LLC. In cases of multi-member it is almost always advisable to have an operating agreement so that there is no doubt as to obligations and entitlements during certain events such as a wind-up or death or a member.
There are many factors to consider when embarking on a new business venture. The choice of entity is important in order to effectuate the intent of the business owners and increase the chances of the businesses success. Additionally, businesses can be structured in a number of ways depending on your needs. Changes to the tax code, the desired taxation of the owners, and the particular kinds of properties and assets being held by the entity all influence the analysis. For specific advice on your proposed business venture, contact your legal and accounting professionals.