The Different Business Entities – Which is Best for Your Business

Ensuring you employ the right entity for your needs will help your business grow in the future. The business entities discussed in this article include sole proprietorships, limited liability companies, general partnerships, various types of limited partnerships, and various types of corporations.

Introduction

There are many types of business entities, each offering its own benefits and costs. Ensuring you employ the right entity for your needs will help your business grow in the future. This article serves as a brief overview of the various types of business entities in the United States.

The business entities discussed in this article include sole proprietorships, limited liability companies, general partnerships, various types of limited partnerships, and various types of corporations.

Sole Proprietorships

A sole proprietorship is the simplest business entity. You are considered a sole proprietorship if you engage in business and do not register as any other type of entity. In a sole proprietorship, one individual owns and operates the business. Sole proprietorships are risky because the sole proprietor is personally responsible for all aspects of the business, including any debts and legal liabilities arising from the business. This means the business owner could lose their personal assets as a result of any lawsuits brought against the sole proprietorship.[1]

Limited Liability Company (LLC)

LLCs are organized under state statutes. Different states regulate LLCs in slightly different ways, so it is important to check your state’s regulations before starting an LLC. LLCs are popular across the business spectrum.  LLCs have been used to form small, individually owned business as well as some of the largest, most valuable business operating today, including Google LLC.

Owners of an LLC are called “members.” An LLC is a separate legal entity, so its members are not personally liable for its legal liabilities.  In most states, members may be individuals, corporations, other LLCs, or foreign entities. Typically, there is no maximum number of members an LLC may have, and most states allow single member LLCs.  One benefit of LLCs is their flexible management structure.  LLCs cannot issue stock and are not publicly traded.

Depending on elections made by the LLC and the number of members, the IRS will treat an LLC as either a: (1) corporation, (2) partnership, or (3) a disregarded entity (as part of the LLC’s owner’s tax return). A domestic LLC with two or more members is classified as a partnership for federal income tax purposes unless it elects to be treated as a corporation. Similarly, an LLC with one member is treated as a disregarded entity for income tax purposes unless it elects to be treated as a corporation.[2] An LLC is a pass-through tax entity unless it elects to be treated as a C Corp (see below).

Partnerships

General Partnerships (GP)

Partnerships are the simplest business structure for two or more people wishing to do business together. GPs are the default form of partnership and generally do not require any forms to be filed with state agencies. In a GP, all partners share in the profits, managerial responsibilities, and liability for debts equally. However, if the partners wish to share profits and losses unequally, they can document this in a partnership agreement. GPs pay taxes on the company’s revenue using the partners’ personal income tax returns.

General partners have a fiduciary duty to act in the best interests of other partners and the partnership generally. While GPs may be beneficial for some business ventures, they do not afford as much protection as other business entities. GPs offer no protection to partners from debts or other legal obligations incurred by the GP. [3]

Limited Partnerships (LP)

An LP provides more protection for the partners than a GP. In an LP, there must be at least one general partner who manages the partnership and is personally liable for its obligations. Also, there must be at least one limited partner who is not personally liable for the partnership’s obligations, shares in the profits of the partnership, and does not have a right to manage the partnership.

In an LP, the limited partners are only liable up to the amount of their investment in the LP. However, if a limited partner takes a more active managerial role in the LP, they could lose their limited partner status and become personally liable.[4]

LPs need to be registered with the Secretary of State. The foundational document for the LP is called a “partnership agreement” that delineates how profits and losses are distributed and how partners may sell their stake in the partnership. LPs are pass-through entities that report their income on the tax returns of the partners who are taxed at individual income tax rates.

Limited Liability Partnerships (LLP)

LLPs are a hybrid business entity that combine aspects of partnerships and LLCs. With LLPs, there is no distinction between general partners and limited partners. In this way, an LLP is like a general partnership. All partners share the responsibilities of the business, but unlike a general partnership, an LLP offers limited liability for all its partners. Like the members in an LLC, all partners in a LLP have limited liability, and all partners can manage the LLP without altering their liability.

LLPs are often used to form professional services companies such as law firms and accounting firms. Some states limit what an LLP can be used for.[5]

Limited Liability Limited Partnership (LLLP)

Unlike LLPs, LLLPs are composed of general partners and limited partners. The general partners manage the business, and the limited partners share in the profits of the business. General partners share fully in the LLLP’s profits and losses, while limited partners share in the profits of the business, but their losses are capped at the amount they invested in the business.

LLLPs are basically ordinary limited partnerships that have elected to add limited liability. The LLLP usually must file a Limited Liability Limited Partnership Registration with the Secretary of State to acquire limited liability status. LLLPs are beneficial because they limit the liability of general partners. In most other respects, LLLPs operate like limited partnerships.  The LLLP is a relatively new business entity that has not yet been recognized by all states, so one must check with their Secretary of State to see if it is available.  The LLLP structure is available in Virginia, D.C., and Maryland.

Corporations

C Corporation (C Corp) Closely Held or Publicly Trade

A C Corp is the most basic type of corporation. C Corps can make profits, be taxed, and are viewed as independent legal entities, so they can be sued for their legal liabilities. Corporations offer strong protection to their owners from personal liability but require more extensive record-keeping, operational procedures, and reporting requirements than other business entities. A corporation has a completely independent life separate from its shareholders.[6]

Unlike sole proprietorships, partnerships, and LLCs, corporations pay income tax on their profits. A C Corp’s profits can be taxed twice. The corporation must first pay taxes on its profits, but then the stockholders must pay personal income taxes on any dividends received from the corporation’s profits.

C Corps can be closely held or publicly traded. Closely held C Corps may employ a less formal corporate structure than publicly traded companies.  Close corps do not sell their stock through public trading and can be run by a small group of shareholders without the typical board of directors. Corporations that are publicly traded can raise capital through the sale of stock. The ability to publicly trade stock, however, requires careful compliance with governmental regulations and oversight.

S Corporation (S Corp)

S Corps are designed to avoid the double taxation of C Corps. S Corps allow for profits and some losses to be passed through directly to the owners’ personal income without being subject to corporate tax rates. To obtain S Corp status, the corporation must also file with the IRS. This is a different process from registering the corporation with the state. S Corps, like other corporations, are governed by state law, so taxation on S Corps can vary between states. For example, some states limit an S Corp’s pass-through abilities and tax profits above a specified limit.

Professional Corporations (PC)

A PC is a type of corporation organized under state statute that allows certain licensed professionals to own shares in a corporation organized to render professional services. Examples of the professions that can incorporate as PCs are attorneys, architects, accountants, engineers, and dentists. The benefit of a PC is that an owner will not be personally liable for the negligence or malpractice of the other owners. However, owners of PCs remain liable for their own negligence or malpractice.[7]

Benefit Corporation (B Corp)

B Corps are for-profit corporations recognized by most U.S. states, including Virginia.[8] B Corps are intended to benefit the public good, so shareholders in a B Corp must strive to ensure the corporation produces a public benefit while making a financial profit. Some states require B Corps to submit annual benefit reports that show their contributions to the public good. B Corps differ from C Corps in accountability and transparency, but they are taxed the same.

Conclusion

In conclusion, there are many different business entities with each providing its own potential benefits. By working with a skilled attorney, you can determine which business entity is best for your business. This blog post is a basic overview of the most common business entities. Individuals seeking to set up their own business should contact Briglia Hundley, P.C.®, at 703-883-0880.

About Us

Briglia Hundley® was founded in 1993 and practices throughout the mid-Atlantic region. The firm features attorneys listed as “Legal Elite” by Virginia Business magazine, named to Super Lawyers, and listed in Best Lawyers.  The firm holds Martindale-Hubbell’s highest AV Preeminent rating for professional skill and ethical conduct.

 

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[1] Choose A Business Structure, SBA, https://www.sba.gov/business-guide/launch-your-business/choose-business-structure

[2] Limited Liability Company (LLC), IRS (Jan. 25, 2023), https://www.irs.gov/businesses/small-businesses-self-employed/limited-liability-company-llc.

[3] See Evan Tarver, Limited Partnership: What It Is, Pros and Cons, How to Form One, Investopedia, (Sep. 5, 2022), https://www.investopedia.com/terms/l/limitedpartnership.asp.

[4] Id.

[5] Id.

[6] Choose A Business Structure, SBA, https://www.sba.gov/business-guide/launch-your-business/choose-business-structure.

[7] Professional Corporation, LII, https://www.law.cornell.edu/wex/professional_corporation.

[8] See Virginia Code §§ 13.1-782 through 791.