Business Entity Basics

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An Old Classic: The Corporation

A corporation is a separate and distinct legal entity. It’s like creating an artificial person has the ability to live forever. A corporation can open a bank account, own property and do business, under its own name. The primary advantage of a corporation is that its owners, known as stockholders or shareholders, are not usually personally liable for the debts and liabilities of the corporation. For example, if a corporation gets sued and is forced into bankruptcy, the owners will usually not be required to pay the debt with their own money. If the assets of the corporation are not enough to cover the debts, in most cases the creditors cannot go after the stockholders, directors or officers of the corporation to recover any shortfall.

A board of directors oversees the management of a corporation. The board of directors are responsible for making major business decisions and overseeing the general affairs of the corporation. Directors are elected by the stockholders of the corporation. Officers of the corporation (i.e. President, Treasurer, etc.), who run the day-to-day operations of the corporation, are appointed by the directors. To remain compliant with the law, corporate officers and directors must hold regular company meetings, the record of which is documented and maintained as the minutes of these meetings.

One major disadvantage of a traditional corporation is double taxation. A traditional corporation, known as a “C” corporation, pays a corporate tax on its corporate income (the first tax). Then, when the “C” corporation distributes profits to its stockholders, the stockholders pay income tax on those dividends (the second tax).

To avoid double taxation, corporations can pay all of its yearly profits to employees or vendors or make a special election to be taxed as a pass-through entity, like a partnership or a sole proprietorship. In other words, there is only one level of taxation. The corporate profits "pass through” to the owners, who pay taxes on the profits at their individual tax rates. Corporations (or LLCs) that make this tax election with the IRS are known as “S” corporations.

The New Kid in Town: The Limited Liability Company (LLC)

Like a corporation, a Limited Liability Company (LLC) is a separate legal entity from the owners of the LLC. The owners of an LLC are referred to as "members” rather than stockholders or shareholders as with corporations and may be member managed or manager managed.

LLCs are becoming more and more popular. They combine the personal liability protection of a corporation with added tax benefits where certain income, deductions, and losses can be passed through the company to the individual tax return of each member (like an “S” corporation). In other words, the members of a LLC are not usually personally liable for the company’s debts and liabilities, and they have the benefit of being taxed only once on their profits similar to a partnership. This is why an LLC is frequently referred to as a hybrid of a corporation and a partnership because it offers the personal liability protection of a corporation along with a lot of the tax benefits and flexibility of a partnership.

The Newest Kid in Select Towns: The “Series” LLC

Delaware created it and Nevada adopted it, but what is it?

A series LLC is like taking a parent company and its many subsidiaries and making them all one company, but separating each “series” or subsidiary into a “cell” that may keep its assets and liabilities separate from the other “cells” and the parent company. The main advantage is less paperwork to keep track of and a reduced amount annual filing fees paid to the state. For instance, say you had a parent company and four separate subsidiary companies. You would have five distinct and separate entities, with five different names, and pay annual fees to the state for each entity. If you had a series LLC chartered in Nevada you would have one entity, one name and pay one-fifth of the annual fees to the state.

The series LLC is particularly useful for real property management, and for entertainment companies. You can have the parent company (the property management company or production company/band) and then series companies for rental properties A through E, or the touring company, publishing company, merchandising company, etc., all separate and distinct for asset and liability protection, but all related for operational ease.

Although LLCs are becoming more and more popular, they should be used only in instances when the specialized nature of the LLC is appropriate. One should proceed with caution when creating a multi member LLC because there is very little settled case law regarding LLCs, their operating agreements can become very complicated, and should litigation between the members ensue down the road, the resolution of the issues leading to litigation are likely very uncertain. This differs from a corporation, where many significant issues that may lead to litigation have been litigated before, and the outcome of a new case is much more certain.

What about other business entities?

Partnerships

General partnerships afford the least protection and the most exposure to you personally. We generally do not suggest the formation of general partnerships, instead we suggest the formation of a new separate entity such as a corporation or LLC.

Joint Ventures

Generally a joint venture is like a partnership, but there are several major differences. When a joint venture is formed it theoretically creates a new entity. The parties may choose a corporation, LLC, partnership or other entity for the venture’s purpose. A joint venture is usually formed by two or more entities for a particular purpose, recognizing that the entities have other business interests that may or may not compete with the particular purpose of the joint venture.

Professional Corporations, Business Associations and Other Special Entities

We can form other specialized entities tailored to fit your needs. Get in touch with us for more information.