Do you know the differences between a corporation and a limited liability company? Do you know the pros and cons of a general partnership, as opposed to a limited partnership or sole proprietorship? In California, a business owner can choose from a variety of structures to form a business entity. If you are stumped as to what structure will best suit the needs of your business, contact an Irvine business attorney to discuss the advantages and disadvantages of each.
The corporation is the most well-known business entity. It is owned by its shareholders and managed by its board of directors. The shareholders, officers, directors, and managers are responsible to pay corporate debts, and taxes. All debts must be paid from the corporate assets; the individuals who work for or own the corporation cannot be held individually liable.
Another great feature of a corporation is that it does not cease to exist just because the shareholders of the corporation die or transfer their shares. Instead, the corporate form will perpetually go on, as long as the board of directors and shareholders follow the proper formal procedures to keep it registered and compliant with state law.
Corporations can issue stock to attract investors and grow the business. Therefore, a corporation is an optimal set up for your new business if you want to sustain constant growth.
Some aspects of corporate status may make it a less desirable form, in certain situations. For example, the board of directors and the shareholders of the corporation must ensure that they always hold annual meetings and carefully record the minutes of those meetings. Furthermore, if the annual Statement of Information is not filed, the state can cancel or dissolve the corporation’s status as a viable entity. Additionally, a tax return must be filed for the corporation itself each year. Last, but certainly not least, the directors and officers are not always 100-percent protected from liability under the corporate form. For example, if certain formalities are ignored, a court may allow a party to “pierce the corporate veil” and individually sue directors and officers for their actions.
If you would like to form a corporation, contact an Irvine business attorney to help you draft the Articles of Incorporation and choose a registered agent. Your attorney will help you fill out the correct forms and pay the appropriate amount of fees to the California Secretary of State.
Limited Liability Company (LLC)
If all the formalities that are necessary to maintain a corporation aren’t preferable in your particular case, then you may want to consider a limited liability company. An LLC is one of the simplest structures you can choose for your business.
The best thing about an LLC is that it provides the same limited liability protections that directors and officers of a corporation enjoy: the owners of an LLC will not be liable for business debts and obligations. Instead, business debts and obligations must be paid from the LLC’s assets.
LLCs have other characteristics of which you should be aware. For instance, the owners may have to pay a self-employment tax if they are working for the LLC. Furthermore, unlike a corporation, an LLC cannot issue stock in order to grow the business. If you want to grow an LLC, your only option is to convert the entity to a corporation.
In California, to create an LLC, you must file Articles of Organization and an Operating Agreement with the Secretary of State. You must also pay yearly franchise taxes to the state.
General Partnership (GP)
General Partnerships are entities comprised of two or more partners who agree to be held jointly and severally liable for the debts and obligations of a business. General partnerships are a great choice if you don’t want to deal with complicated state filings and taxes. We recommend that you hire an Irvine business attorney to draft and file a Statement of Partnership Authority with the Secretary of State. Although a partnership agreement is not required in California, unless your GP has that written document, you have no evidence of the intended partners’ roles or what procedures must be followed to end the partnership.
Just remember, as with any business entity, a GP requires that you must apply for and pay the fees for any business licenses and permits required by the state and your locality.
General Partnerships don’t require complicated recordkeeping. You can comingle your personal funds with the business funds freely. Moreover, a general partnership, as an entity, is not taxed. To report taxes, use IRS Form 1065 and a Schedule K for each partner.
Limited Partnership (LP)
If you have a short-term project for which you need a business entity formed, a limited partnership is probably your best bet.
In a limited partnership, there is one general partner and one or more limited partners. The general partner has unlimited liability for the entity and is responsible for managing and controlling daily business operations. On the other hand, the limited partners have limited liability – their personal assets can’t be touched to pay off partnership debts or obligations. The limited partners’ liability is restricted to the amount of money each has invested into the partnership. Consequently, limited partners are essentially just investors. They can lose their investment, but nothing more.
Unlike a general partnership, a limited partnership must be formed by filing with the California Secretary of State and paying the filing fee. The form that must be filed to create your limited partnership is called a Certificate of Limited Partnership. The limited partnership itself pays no taxes. The general and limited partners each report taxes via IRS Form 1065 and a Schedule K.
The easiest and cheapest business form to use is the sole proprietorship. In most situations, you don’t have to file or register with the state to start a sole proprietorship; you just start working. However, if your business will not be using your name, but a name you’ve made up, you have to file a Fictitious Business Name Statement in the California county in which your business is located. Additionally, a sole proprietor must obtain any necessary business licenses or permits required by the state of California or your specific locality.
This type of entity is best for small businesses operated from one’s home where there is little chance of liability involved. A sole proprietor may hire employees; however, no individuals other than the sole proprietor own or control the business. If you hire employees, you want to make sure that you comply with all federal and state requirements to be an employer. If you are the only individual working for your business, you can simply report self-employment earnings to the IRS on Schedule C.
A sole proprietor can be sued individually and personal assets can be used to pay the judgment. Therefore, if you feel that your business has a high chance of incurring liability, you may either want to heavily insure your business or change your business form to that of a corporation or LLC.
Avoid surprises down the road by getting your business off to the right start. Call us, at 949-861-2524, to schedule a time to meet with our Irvine business attorneys to discuss your business plans and goals. If you prefer, use the Confidential Case Evaluation form on this page to tell us about your situation. We will respond promptly.