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Overview of Business Organizations
See Also:
Business
Organizations
When choosing an appropriate
business entity, it is important to consider numerous factors, such as ease of
formation, Federal and State income tax laws, management rights and control,
liability for losses, transferability of ownership interests, and continuity.[1]
Sole
Proprietorship
A sole
proprietorship is an unincorporated business owned by a single person. This
business entity form usually does not require governmental filing, other than a
fictitious-business-name statement, which provides the owner’s name and address
and the name under which the owner will conduct business.[2]
The main advantages of this business entity form is the owner’s absolute
control in terms of management rights, and avoidance of double taxation, as a sole
proprietorship is not a separate legal entity.[3]
The sole proprietor reports the business’s expenses and income on his or her
personal income tax return.[4]
The main disadvantage of a sole proprietorship is the owner’s unlimited
personal liability for the losses of the business.[5]
The sole proprietor can freely transfer interest in the business, but the death
of a sole proprietor will dissolve the sole proprietorship.[6]
Notably, sole proprietorships can also be a “default” entity because if a
single person conducts a business without filing with a state to form some
other entity (an LLC for example), the business will be considered a sole
proprietorship.
Partnerships
There are various kinds of
business partnerships, including general partnerships, limited partnerships (LP),
limited liability partnerships (LLP), and limited liability limited partnerships (LLLP). Partnership law originated in the common law; however, it is now
codified in the Uniform Partnership Act and the Revised Uniform Partnership
Act.[7]
General
Partnership
A general partnership is an
unincorporated business association that does not require any filings with a state. A general partnership is formed whenever two or more persons co-own a
business for profit.[8] As such, general partnerships can be created by
default.[9] The main characteristics of general
partnerships are: Each partner has unlimited liability with respect to the partnership;
each partner has equal rights to management and control; only the partners are
taxed (the partnership by default is not a separate taxable entity, though tax
filings can be made to elect otherwise); the financial interest of each partner
is freely transferable, but all partners need to agree in order to transfer membership
in the partnership; and, lastly, general partnerships have advantages in terms
of continuity, since death, bankruptcy, or withdrawal of a partner usually does
not dissolve a general partnership (under the Revised Uniform Partnership Act).[10]
Limited
Partnership (LP)
A limited partnership is an
unincorporated business association that requires filing of a certificate of
limited partnership with the state.[11] Each limited partnership must have at least
one general partner and at least one limited partner.[12] The main characteristics of limited
partnerships are: General partners have unlimited liability for partnership
debts; while limited partners have limited liability, general partners have
equal management and control rights and limited partners have no management and
control rights; a limited partnership may elect not to be a separate taxable
entity in order to avoid double taxation, except for publicly traded limited
partnerships which are subject to corporate income taxation; partners may
assign their financial interests in the partnership, but the assignee can
become a limited partner only if all partners consent; and, lastly, only death,
bankruptcy, or withdrawal of a general partner will dissolve a limited
partnership.[13]
Limited
Liability Partnership (LLP)
A limited liability partnership
is an unincorporated business association that requires filing of a certificate
of limited liability partnership with the state.[14] Limited liability partnership is essentially
a general partnership that enables
partners to limit their liability for misconduct of other partners, but each
partner has unlimited liability for their own misconduct.[15] The limited liability partnership is
typically used by professional partnerships, such as law firms or accounting
firms, because state law restricts professional partnerships from organizing as
limited partnerships. Apart from specific filing requirements and the ability
to limit liability, limited liability partnerships are no different than
general partnerships.
Limited
Liability Limited Partnership (LLLP)
A limited liability limited
partnership is an unincorporated business association that requires filing of a
certificate of limited liability limited partnership with the State.[16] A limited liability limited partnership is
essentially a limited partnership that enables general partners to limit their
liability, just like in an LLP.[17] Apart from the ability to limit liability of
general partners, limited liability limited partnerships are no different than
limited partnerships.
Limited
Liability Company (LLC)
Limited Liability Company is an
unincorporated business association that requires filing with the State.[18] An LLC combines the benefits of partnership
laws with the benefits of corporation laws. In an LLC, all of its members have
limited liability, but each member can participate in management decisions,
which makes LLCs very attractive.[19] On top of that, in a properly structured LLC,
only the members are taxed, as the LLC may elect not to be a separate taxable
entity.[20] If an LLC has only one member, it is taxed as
a sole proprietorship by default, unless the member elects to have the LLC
taxed as a corporation (which is rare).[21] Typically, members may assign their financial
interests in the LLC, but an assignee can become a member only if all members
consent, or if the LLC’s operating agreement provides otherwise.[22] It varies from State to State whether death,
bankruptcy, or withdrawal of a member necessarily dissolves an LLC, and the
State default rules can often be modified by the LLC operating agreement.
Corporations
A corporation is a business
entity form whose existence is distinct from those that own it and/or manage it.[23] The main characteristics of a corporation
are:
(1) it can be formed only by
filing with the state, and filings must substantially comply with a state
incorporation statute;
(2) it is a separate legal
entity from its owners and/or managers and, as such, it can independently sue,
be sued, contract, and hold title to corporate property;
(3) its management is heavily
centralized, and those in management do not even have to be shareholders;
(4) shareholders generally have
limited liability for the corporation’s debts and legal obligations;
(5) unless otherwise specified
in the articles of incorporation, a corporation has perpetual existence, so death
or withdrawal of a shareholder or those in management will not terminate the
existence of a corporation;
(6) ownership of corporate
shares is easily transferable;
(7) a corporation itself can be
considered a “person” or a “citizen.” Such classification is important for
corporations because “personhood” entitles corporations to many important protections
provided in the Constitution of the United States of America, while
“citizenship” is important for jurisdictional issues in litigation; and
(8) since a corporation is a
separate legal entity, it is subject to double taxation, unless it elects to be
taxed as an S Corporation (so called because it is taxed under Subchapter S of
the Internal Revenue Code).[24] Under the double taxation principle based on
Subchapter C of the Internal Revenue Code, the income of the corporation itself
is directly taxed, and corporate profits are taxed separately a second time in
the hands of the corporation’s owners once they are distributed.[25]
S Corporations
In order to
become an S corporation, a corporation must submit specific forms to the
Internal Revenue Service signed by all the shareholders (Form 2553 Election by
a Small Business Corporation).[26]
Becoming an S Corporation allows corporations to avoid double taxation on the
corporate income by passing corporate income to their shareholders for federal
tax purposes (it also enables a corporation to pass losses, deductions, and
credits to their shareholders).[27]
In essence, becoming an S corporation enables corporations to be taxed as a
partnership. The corporation must meet the following requirements in order to
qualify for S Corporation status:
(1) it must be a
domestic corporation;
(2) it must have
only allowable shareholders, who may be individuals, certain trusts, and
estates, but may not be partnerships, corporations or non-resident alien
shareholders;
(3) it cannot
have more than 100 shareholders;
(4) it must have
only one class of stock; and
(5) it must not
fall into an ineligible corporation category, such as certain financial
institutions, insurance companies, and domestic international sales
corporations.[28]
Footnotes
[1] Richard A. Mann & Barry S. Roberts, Smith’s
& Roberson’s Business Law 668-670 (15th ed. 2012).
[2] Roger Meiners, Al
H. Ringleb, & Frances L. Edwards, The Legal Environment of
Business 368 (11th ed. 2011).
[3] Id.
[4] Id.
[5] Id.
[6] Id.
[7] Id. at 368.
[8] Revised Uniform
Partnership Act (“RUPA”) § 101(6).
[9] RUPA § 202.
[10] Mann & Roberts, supra note 1, at 598.
[11] Revised Uniform
Limited Partnership Act (“RULPA”) 201.
[12] RULPA § 101(7).
[13] Mann & Roberts, supra note 1, at 645-650.
[14] RUPA § 1001(c).
[15] Mann & Roberts, supra note 1, at 654.
[16] Id.
[17] RULPA § 102(9); RULPA §
404(c).
[18] Meiners, Ringleb, & Edwards, supra note 2, at 380-383.
[19] Id.
[20] Id.
[21] Id.
[22] Id.
[23] Mann & Roberts, supra note 1, at 668-670.
[24] Id.
[25] Constance E. Bagley & Craig E. Dauchy, The
Entrepreneur’s Guide to Business Law 56-58 (4th ed. 2011).
[27] Id.
[28] Internal Revenue Code § 1361(b).