Most people want to form a business entity to limit their personal liability. This can be accomplished with a corporation, a limited liability partnership, or an LLC. Which entity is right for you depends on your situation. Generally, there are structural differences in ownership, differences in management and control, differing tax consequences, and differing limitations on liability. If you are thinking about forming a business entity you should review the characteristics of different entities provided below.
Partnerships
Partnerships enjoy pass-through income tax status. The partnership itself is not taxed. The income and losses of the partnership pass through to the partners who report their shares of income and losses individually.
LP’s, LLP’s, LLLP’s, and LPA’s
LP’s, LLP’s, LLLP’s, and LPA’sIt is important to know that a partnership may be formed inadvertently, and that individuals may unwittingly become liable for the actions of their “partners” and debts of a partnership they did not know existed. You do not need to shake hands and agree to be partners to form a partnership. A partnership may be formed without filing any paperwork and without any intent to form a partnership. If there is an association to carry on and manage as co-owners a business for profit, you have formed a partnership. If you have formed a partnership, even inadvertently, you may become liable for the debts of the partnership and the actions of your partners. When the partnership dissolves any partner may petition the courts to determine his or her rights with regard to assets and debts of the partnership. If you are engaged in an informal partnership, or if circumstances exist such that your “partner” or anyone else could argue that you have formed a partnership, it is important that you consult with an attorney and take measures to protect yourself from personal liability. If you are engaged in a partnership, and the partnership is ending, you should speak with an attorney about your rights with regard to the assets, profits, and debts of the partnership.
Registered Partnerships take a variety of forms. In Colorado you may register a limited partnership, a limited liability partnership, a limited liability limited partnership (yes, you read that correctly), or a limited partnership association. When deciding which form is right for your situation you should consider who will manage the partnership, the differing liability consequences, and the differing consequences upon dissolution of the partnership.
- Limited Partnerships – A Limited Partnership is an entity which has at least one general partner and one limited partner. Management responsibilities are usually vested in general partners, while limited partners usually contribute capital but do not take part in the management of the business. The limited partners’ liability is limited to the extent of their capital contribution, while the general partners remain liable for all obligations of the partnership. Since the advent of limited liability limited partnerships this form of entity has become less common, with most business owners choosing to take advantage of the greater protection provided by LLLP’s, which extend liability protection to both limited partners and general partners. However, the limited partnership may still be useful in some contexts (such as estate or family planning) because of simplified tax and filing requirements.
- Limited Liability Partnerships – In a LLP partners are shielded from personal liability for the debts and obligations of the partnership and from liability for the negligence or wrongful acts of other partners. A partners’ liability is limited to the extent of their capital contributions to the partnership. Management authority is shared equally among the partners unless otherwise agreed.
- Limited Liability Limited Partnerships – A LLLP is structured like a limited partnership. Management responsibilities are vested in the general partners, while the limited partners usually make capital contributions, but do not take part in the management of the business. However, with LLLP’s, both general partners and limited partners are shielded from personal liability for the obligations of the partnership.
- Limited Partnership Associations – A LPA is similar to a corporation in some ways, but is taxed like a partnership. The owners of a LPA are known as members, and they have limited liability for the debts and obligations of the association. LPA’s are designed to survive the dissociation, death, or bankruptcy of a partner, terminating upon the affirmative vote of all members or as otherwise provided in the bylaws. Management responsibility may be shared among the members or vested in managing members.
Limited Liability Companies
Like partnerships, LLCs enjoy pass-through taxation, allowing members to report their own shares of income and losses individually, while the income of the LLC itself is not taxed. LLCs were designed to provide flexibility in ownership and management while preserving the benefits of pass-through taxation found in partnerships. LLCs are owned by their members. Members may share in management or they may appoint a manager. The ownership interests and management responsibilities of the members are set forth in an operating agreement. A LLC may have only one member and can be used as a vehicle to protect sole proprietors from personal liability for the debts and obligations of their business. However, A LLC operating agreement can also define relationships among a multitude of business parties, allowing them to contractually create almost any business arrangement they feel is appropriate to their situation. The liability of LLC members is limited to the amount of their capital contributions to the LLC.
Corporations
There are a number of formalities which are required of corporations. They must hold regular meetings, record minutes of those meetings, keep certain business and financial records, and make annual reports to the state and to shareholders.A corporation is the most formal and complex business entity. Corporations are owned by shareholders. The shareholders elect a board of directors who manage the corporation or the board of directors may appoint officers to manage. The operational structure and management of a corporation is laid out in articles of incorporation and corporate by-laws. The liability of corporate shareholders is limited to the amount of their investment.
- C-Corporations – By default all corporations are C-Corporations. C-Corps are subject to double taxation. Income of the corporation is taxed and then upon distribution to shareholders it is taxed again, as individuals who receive distributions of corporate funds are taxed on the income. This form of corporation is always used if you will have more than 100 shareholders. This is the corporate form you would use if you want to issue stock to raise funds for example. A C-Corp is usually not the right choice for small businesses, however, it may have tax advantages if you provide employee benefits or if a majority of profits are invested back into the business, due to low tax rates on retained earnings.
- S-Corporations – Most small businesses elect to file as an S-Corporation because S-Corps have pass-through tax treatment, much like a partnership or LLC. The Corporation’s income is not taxed, rather, shareholders pay taxes on the income they receive from distributions of corporate funds. They also deduct expenses and claim losses individually. When forming an S-Corp you must file an S-Corp election with the IRS early on to ensure S-Corp tax treatment.
- Professional Service Corporations – Professional service corporations (PC’s) are for individuals engaged in certain business professions. They protect the individual by insulating them from personal liability for the debts and obligations of the PC. In Colorado this form of business entity is only available to:-Certified Public Accountants
-Architects
-Chiropractors
-Dentists
-Engineers
-Land Surveyors
-Lawyers
-Optometrists
-Physical Therapists
-Physicians and Surgeons
-Podiatrists
-Professional Counselors
-VeterinariansProfessional associations, such as doctor or dental offices, are often set up as a LLP composed of several professional service corporations.
How do I file to create a business entity?
The filing requirements vary depending on what type of business entity you are creating. First you need to check to make sure the name you have chosen for your business is still available. You may verify availability of your business name through the Secretary of State’s records search page. Register your entity name with the Secretary of State and set up a secure business record. The documents you will need to file with the State of Colorado and the IRS can vary greatly depending on your situation. You may also be required by law to keep certain business records depending on what type of entity you form. You should consult with an attorney to ensure that your business is set up and registered properly.