Business Entity Compliance from BizFilings - Partner with the Industry Leader
Learn more about protecting your personal and company assets.
If you are in business for yourself, that business is likely to be your riskiest undertaking. Therefore, it makes sense to consider carefully the organizational form in which your business is conducted. Although you can choose to run your business as a sole proprietorship, partnership, corporation or limited liability company (LLC), in most cases the LLC will offer the most effective protection for both your personal assets outside the business and your investment in the business itself.
The following are brief summaries of some of the key characteristics of the organizational choices that are available to the business owner.
A sole proprietorship is the simplest business form. However, it places the owner's assets at great risk, provides limited tax and estate planning options.
A general partnership is another business form that it easy to create, but risky to operate because of the far-reaching liability exposure. Partnership taxation can rapidly become extremely complex, particularly if there are ownership changes.
There's very little upside to operating as a general partnership.
A limited partnership is a relatively easy structure to adopt and operate; plus it provides some liability protection to at least some of the owners. However, in order to gain the liability protection, you must forfeit the right to be involved in running the business. This makes it a poor choice for a small business owner, unless the LP registers to become a limited liability partnership (LLP).
Before the advent of the LLC, its limited liability and flexibility made the C corporation one of best ways to structure a business. It still is a viable choice for many businesses.
In a small group of states, the corporation may be formed as a statutory close corporation, which operates more like a partnership or LLC. This option can offer significant advantages over a conventional corporation.
Once formed, a corporation can make an election to be treated as a conduit for federal tax purposes - and therefore becomes an S corporation. This eliminates the possibility of double taxation, while retaining the benefits of the corporate form.
A limited liability company is often the best choice for a business. The LLC offers simplicity, flexibility and limited personal liability from business creditors.
Some types of professions are limited when choosing an organizational form for your business. When state laws were changed to allow professionals, such as doctors, lawyers, engineers, etc., to form corporations, the laws imposed certain conditions on this choice.
Specifically, most state laws require that:
All states, except California, now allow professionals to form limited liability companies (LLCs) as well as corporations. All of these states impose on the LLC the same first condition imposed on the PC--all of the owners must be licensed in the same profession. However, curiously, many states do not impose the second condition on LLCs. Accordingly, in these states, no special designation other than the standard LLC is required in the name of the business. In some states that do impose the second condition on LLCs, the term "PLLC" (professional limited liability company) is used.
If you are considering a professional LLC, find out if the state in which you are forming requires you to use a designation such as "PLLC" in the business's name. In addition, it is always a good idea to check with the professional association in your state to determine if there are any special ethical rules regarding the operation of an LLC.
In California, professionals cannot operate in the LLC form, and a one-owner professional business must be formed as a corporation. However, in California, two or more professionals have the choice of operating in the form of an limited liability partnership (LLP) (in the case of accountants, architects and lawyers) or a corporation. Despite its many shortcomings, California does offer full shield protection in the LLP, not the limited shield as in some states.
Both New York and California limit the use of LLPs to professionals, and in California this means only lawyers, architects and accountants.
Finally, where professionals operate in the LLP form, many states impose mandatory insurance requirements on the owners. Because mandatory insurance is likely to be expanded in the future, professionals in LLP states that do not require it now, and professionals operating in the form of LLCs or corporations, should check with state authorities or their professional association for updates in this area.
As noted earlier, when comparing the limited liability company (LLC) to other types of entities, an LLC will usually be the best choice for most small business owners seeking to maximize asset protection strategies. This form also provides significant tax and estate planning options and it very flexible to operate.
The LLC offers significantly better protection from the claims of the owner's personal creditors. Many states follow the Revised Uniform Limited Partnership Act view (developed from limited partnership law) in preventing a personal creditor with a charging order against an LLC from foreclosing on an owner's LLC interest and forcing a liquidation of the business.
This rule has never applied to corporations. Thus, in contrast, a personal creditor with a charging order against a corporation may attach and vote the interest of an owner of a corporation. A creditor may force a liquidation of the business to satisfy the debt if the debtor's interest was a majority interest, but at any rate it can vote the shares in other ways disadvantageous to the business owner.
The relative simplicity/low cost and the limited restrictions on LLC operations reduces the likelihood that the doctrine of piercing the veil of limited liability will apply to an LLC. When this doctrine applies, unlimited, personal liability is imposed on the owners for the business's debts.
One common way this doctrine is applied is by proving that the owner has not followed all of the statutory formalities applicable to corporations, regarding division of authority among the shareholders, officers and directors; the holding of regularly scheduled meetings; notice, quorums and waiver requirements for meetings; etc.
A statutory close corporation can achieve some of these same benefits. However, even the statutory close corporation does not change the fact that your personal creditors can attach and then vote your shares to liquidate the business, when this would not be possible in an LLC, in most states. Thus, the statutory close corporation probably should be used in place of the LLC only when self-employment taxes represent an important issue or state registration fees for the LLC are excessive.
The LLC is better suited to being combined with other assets protection strategies, including domestic asset protection trusts and estate planning.
If you expect your business to be lucrative (most small business owners do!), you should consider forming a holding entity in Delaware, in part to facilitate the creation of an asset protection trust there. These trusts are formed as an overall part of an asset protection plan. Thus, it makes sense to form the business entity as an LLC, because the LLC offers better asset protection, at least with respect to the claims of the owner's personal creditors against the owner's business interest.
The LLC is also a better choice when it is part of an estate planning strategy of transferring wealth to the next generation, free of estate taxes. While a complete discussion of estate planning is beyond the scope of this section on asset protection, the small business owner interested in protecting assets should at least be familiar with some of the basics of estate planning, and how the LLC can play a role in eliminating estate taxes. In particular, the use of a family limited partnership has proved to be an effective device to transfer wealth to the next generation free of federal estate taxes. The family limited liability company is now being used for this purpose.
In addition to choosing a business form, the owner must also decide how to structure and fund the entity, and in which state to form the entity, which includes decisions about doing business across state lines, foreign qualification and selecting a registered agent. These decisions also can have important asset protection implications.
Business Entity Compliance from BizFilings - Partner with the Industry Leader
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