One of the single most important decisions anyone has to make when they start their own business is which business entity to choose. Should you structure your new business as a sole proprietorship, a general partnership, a limited partnership or a limited liability partnership? Or would a corporation or S corporation be better? What about a limited liability company (LLC)? Let’s find out.
Basic considerations when choosing a California business structure
In truth the best structure for your Los Angeles area business is largely dependent on several factors. First, what type of business are you starting? Is it a retail business, will you be offering professional services, or doing something entirely different? Are you going into business by yourself, or with one or more partners? Are you more concerned about the tax implications, or liability? What about management? Who will make the decisions?
Once you have these answers, you are a big step closer to choosing a business structure. The next step is learning the different characteristics of each business entity, so you can select the one that best suits your needs.
Characteristics of sole proprietorships, general, and limited partnerships
Let’s begin with the most basic type of business structure – a sole proprietorship. In this type of arrangement, an individual or husband and wife owns the business. Accordingly, the owner(s) in a sole proprietorship have complete control over all business operations. Another benefit is that a sole proprietorship can only be dissolved if it stops doing business or when the owner(s) die. Furthermore, because there is no separation between the business and the individual(s) that own it, there is no additional tax liability. In other words, any income tax owed is reflected on their personal returns.
That’s the good news. The bad news is that the owner(s) are liable for any business debt incurred through a judgment or otherwise. This means their personal and business assets may be at risk.
In comparison, a general partnership is a business entity created through a partnership agreement made between at least two parties (including couples doing business together as registered domestic partners). However, this definition only applies as long as they are engaged in the business to make money. In this type of business arrangement each partner has a say in management, unless the partnership agreement stipulates otherwise. Dissolution of the business occurs automatically unless the partnership agreement includes different provisions.
Like sole proprietors, general partners are liable for all business obligations incurred through judgments or otherwise. Technically, the partners are jointly and severally. This means they are liable as a group and as individuals, in most cases.
Finally, business profits count as income for each general partner’s personal tax purposes. Each partner can also deduct business losses against other sources of income.
Next are limited partnerships. This business entity features ownership by general partners and limited partners. General partners are solely in charge of management and oversee daily business operations. Limited partners (who usually provide financial backing or similar consideration for the business venture) only have a say in management as board members. The dissolution of limited partnerships occurs automatically in absence of partnership agreement stipulations to the contrary.
While general partners have unlimited liability for any business debts, that is not so for limited partners. In most cases, the liability for limited partners cannot exceed the value of their financial or actual business contributions.
A limited partnership must file taxes as separate entity. It must also meet certain standards so it won’t be taxed as a corporation.
Limited liability partnerships in California
In California, only certain professionals can form limited liability partnerships (LLPs). These include architects, engineers, land surveyors, lawyers and accountants.
In this type of business arrangement, the partners own the business and have the right to manage it themselves. They are not liable for any business debts and conditions for the dissolution of the business varies.
Like a limited partnership, an LLP must file taxes as a separate entity and meet certain criteria so it won’t be taxed as a corporation.
Los Angeles corporations and limited liability companies
There are two different types of corporations in California. A traditional or C corporation is differentiated from other business structures because its existence is not tied to its owners – the shareholders. The legal separation between the corporation and the shareholders means that the business can continue even after the owners die.
The shareholders are responsible for electing a board to manage the business. Because they are not otherwise linked to the corporation, shareholders are shielded from personal liability for business debts. However, both the shareholders and the corporation are responsible for paying any applicable taxes.
A so-called S Corporation shares many characteristics with a C corporation. In fact, the only difference is the way in which taxes are handled. In an S corporation income and loss are passed through shareholders.
The last business entity is the limited liability company, or LLC. In this arrangement, the members own the business and oversee its operations unless a manager is chosen to do so. Members are shielded from personal liability for any business indebtedness exceeding the value of their financial contributions to the company. An LLC’s ability to survive beyond the death of the members is based on state requirements. Although it can be taxed as a corporation any income or loss is passed through members.
The LA business lawyers at LawPLA are always here to help
As you can see, there is a lot to consider when it comes to choosing a business entity. Given the importance of this decision, it is easy to see how you could be confused, intimidated or overwhelmed. Fortunately, the business attorneys here at LawPLA are here to help. Just give us a call or use the form on our contact page to set up your initial consultation. Then we’ll work through your questions and concerns to identify the business entity that is best for you.