|
Types of Business Entities
When starting a business there are many different formats
available. In
fact, there are so many choices it can be quite dizzying. In general the types of
businesses can be broken down into two distinct groups Corporations,
and Unincorporated Associations. Most people recognize a
corporation when they see one.
Unincorporated Associations are sometimes a bit less familiar
to the general public, but actually can offer a better choice of
business entity than your standard corporation in some
situations.
Unincorporated Associations are all based on a partnership
format. The last 10 to
15 years have seen an explosion of new forms of unincorporated
associations (namely Limited Liability Companies) that meld together
traditional concepts of partnership law with some of the more
desirable features of corporations. The following is a brief
discussion of the types of entities a business can be organized as
in Colorado.
Unincorporated
Associations
Sole
Proprietor
Technically speaking a sole proprietorship
is not a business entity – it is merely an individual engaged in a
business activity.
Therefore, it is the simplest way to organize a
business. All revenues
and expenses of your business operations are reported on schedule C
to your individual tax return.
You do not pay social security tax, but are subject to a 15%
self employment tax in addition to federal and state income tax on
all income. If you are
going to transact business under any name other than your own, you
will need to obtain a trade name. The advantage of a sole
proprietorship is it is the simplest structure possible. Likewise it is the most
simple to administer and includes virtually no set up costs. The downside to a sole
proprietorship is the fact that it offers absolutely no liability
protection. There is no
distinction between the company and the individual. Therefore the sole
proprietor is personally liable for all debts and acts of the
company. If a sole
proprietor defaults on a debt or is sued and the plaintiff prevails,
the plaintiff or lender can satisfy the judgment with the sole
proprietor’s personal assets (home, car, bank accounts, investment
accounts and other personal property).
Partnerships
Partnerships are technically defined as an association of two
or more persons to carry on as co-owners of a business for profit,
excluding an association formed under any other statute. Partnerships come in several
different “flavors”, each with its own set of pros and
cons.
General Partnership
The General Partnership can be considered the baseline for
all of the different types of partnerships. All partnerships are formed
by an agreement among the partners. In a general partnership
this agreement may be very simple and unwritten or be very complex
governed by lengthy written contracts. Because partnerships are
created and governed by contracts they are very flexible and can be
created in such a manner to meet the individual needs of each
partnership. There are
no official filing requirements with the state in order to form a
General Partnership.
Partners in a general partnership may be individuals,
corporations, other legal entities (such as trusts) or other
partnerships.
Management of the partnership is done by the partners, and
unless the partnership agreement states otherwise, decisions are
made by a majority vote of the partners. Unless otherwise provided
for in the partnership agreement, general partners share profits and
losses equally. For tax
reporting, the partnership files a form 1065 with the IRS and issues
each partner a K-1 allocating to that partner their share of the
profits or losses. Unless operating under
the names of the partners, a partnership must file for a trade name
with the state. Similar
to a sole proprietorship, each partner in a general partnership is
personally liable for the partnership liabilities. In fact type of liability
for general partners is called “Joint and Several”, which means that
any one partner can be held responsible for the full amount of the
partnership’s liabilities. Additionally, unless
otherwise stated in the partnership agreement a General Partnership
is dissolved upon the disassociation (willful withdrawal, death, or
filing a voluntary or involuntary petition of Bankruptcy) of any
partner.
Limited Partnership
A Limited Partnership (LP) is a partnership in which there is
at least one general partner who actively manages the business and
who is personally liable for the obligations of the business and one
or more limited partners who have no liability for the obligations
of the business but cannot have an active role in managing the
company. Only the
general partner has the authority to bind or take action on behalf
of the partnership.
LP’s are formed by filing a certificate of limited
partnership with the state. As with all partnerships they
are governed by a partnership agreement among all of the
partners. Unlike a
general partnership, unless otherwise modified in the partnership
agreement the allocation of profits and losses in a LP is based on
each partner’s contributions (value of cash, personal property or
services) to the partnership. Unless provided for in the partnership
agreement, a LP will survive the disassociation of a general partner
or a limited partner.
Upon the disassociation of the last remaining general
partner, the limited partners may continue on, or may choose to
dissolve the partnership by a majority vote of the remaining limited
partners.
Limited Liability
Partnership
A Limited Liability Partnership (LLP) is a General
Partnership in which the partners are not personally liable for the
debts and obligations of the General Partnership. LLP’s are formed by filing a
Certificate of Limited Partnership and registering a Limited
Liability Partnership registration statement with the Secretary of
State’s office. LLP’s
must also appoint a registered agent that is on file with the
Secretary of State of Colorado. As with a General
Partnership, decision making in a LLP is done by a majority vote of
the partners, and all partners have a statutory right to participate
in the management of the business. Unless otherwise
provided in the partnership agreement, all profits and losses are
shared equally among the partners. The disassociation of a
partner will not dissolve the partnership unless the disassociation
will leave the partnership with only 1 partner. Unlike the other
partnerships discussed so far LLP’s by statute are subject to the
theory of piercing the corporate veil where the individual partners
may be responsible for partnership obligations and liabilities in
certain situations. The
theory of Piercing the Corporate Veil is discussed more in the
description of corporations.
Limited Liability Limited
Partnership
A Limited Liability Limited Partnership is defined as a LP
(see above for requirements) that has registered as a LLLP under the
Colorado Uniform Partnership Act with the State of Colorado. The attributes and
restrictions of a LP will apply, except that all partners not just
the limited partners are shielded from personal liability for the
obligations of the partnership. However, the theory of
Piercing the Corporate Veil applies to the General Partners, which
would allow personal liability against the general partners in
certain situations.
Lastly, it is currently unclear as to how a LLLP will be
treated in a bankruptcy context valid arguments could be made for
treating it as a partnership as well as a corporation.
Limited Liability
Company
A Limited Liability Company (“LLC”) is a quasi corporate,
quasi partnership entity.
It allows for limited liability of the owners (“Members”) and
the ability to separate ownership from management of the company
similar to a corporation, while allowing for the recognition of
profits and losses to be passed through directly to the individual
Members and the flexibility of having the relationship of the
members to each other and the LLC being defined and governed by
contract, similar to partnerships. Management of the LLC can
range from informal arrangements to very complex agreements similar
to partnerships. The
Members may manage the LLC themselves or appoint independent
managers to run the day to day operations. This aspect makes LLC’s good
for passive investment situations such as land deals or restaurants
where the financial backers may not have the necessary skills to run
the day to day operations of the company. There are no limitations on
the number or type of Members a LLC may have, as is the case with a
S Corporation. In
Colorado this includes single
member LLC’s. In
addition, the individual creditors of a Member may not obtain
ownership of the LLC interest, but can only obtain a charging order
which will entitle them to the respective Member’s distributions
from the LLC.
Corporations
Most people are familiar with the concept of a
corporation. The first
thoughts that come to mind are usually very large Fortune 500
companies whose stock is publicly traded. While this is certainly one
incarnation of a corporation, corporations come in various sizes and
can be publicly or privately held. In general, there are two
types of for profit corporations C-Corps and S-Corps. Each type is discussed in
more detail below.
C- Corporation
(“C-Corp.”)
A C-Corp is your standard variety
corporation. It is a
separate and distinct legal entity apart from its owners. Corporations are authorized
by state statute and are formed by filing articles of incorporation
with the Secretary of State in the state of incorporation. The owners of the
corporation are called shareholders. The shareholders elect a
board of directors annually who are in charge of the operation of
the company. The board
of directors appoints officers (CEO, President, Treasurer, Secretary
etc.) who are in charge of the day to day operations of the company
and report to the board of directors. Most decision making power
lies with the board of directors, except for certain major decisions
which need to be ratified by the shareholders. Shareholders are only liable
for the obligations of the company up to their investment (assuming
that the corporation is following the required corporate
formalities).
C-Corps are taxed federally and at the state level on any
profits they generate.
Shareholders are also taxed on the dividends they receive (if
any) and on any gain they receive from the sale of their stock. This is usually referred to
as double taxation, which is usually undesirable for small closely
held businesses.
S-Corporation
(“S-Corp.”)
All S-Corps start out life as a C-Corp. In order for a C-Corp to
become an S-Corp, the corporation must file a S-Corp election with
the IRS (Form 2553).
The only difference between a S-Corp and a C-Corp is how the
entities are treated for tax purposes and the fact that a S-Corp has
restrictions on the number of classes of stock it can issue and the
number and type of shareholders it may have. If a corporation elects to
be classified as a S-Corp. the profits of the corporation will not
be taxed at the corporate level, but will be passed through to the
individual shareholders and taxed at their individual tax rate. In some instances
owner/employees may have certain tax benefits by being able to take
a salary and receiving the rest as dividends which would be taxed at
the capital gains rate.
In order to qualify for the S election, a corporation must be
a domestic corporation and have less than 75 shareholders and have
only one class of stock.
All shareholders must be individuals, tax exempt
organizations or certain allowable trusts, and there cannot be any
non resident alien shareholders (foreign nationals, temporary visa
holders or illegal immigrants). Additionally, corporations
in certain business sectors, such as insurance companies cannot be
S-Corps.
Back to Business Startup
HOME | 
