TYPES OF BUSINESS ENTITIES
The Law Offices of Hintermeister & Kundel has extensive experience helping clients create the following business entities:
The majority of large companies are corporations. Corporations have limited liability, meaning that shareholders can lose their investment but not their personal assets. If the industry you wish to start a business in has a high level of risk and liability, you should consider setting up a corporation.
A partnership can be used by two or more individuals who wish to carry on a business for profit. Unlike a corporation, in a partnership each partner is liable for the debts and legal responsibilities of the partnership. And each partner is also jointly and severally liable for the actions of the other partner. Partnerships have concerns – see below.
- Limited Partnerships
A limited partnership is similar to a general partnership. The difference is there are two types of partners in a limited partnership: general partners and limited partners. Limited partners have no responsibility in the management of the partnership and are only liable for their personal capital investment. Moreover a limited partner is not liable for the debts of the partnership. If a limited partnership becomes insolvent, creditors can only look to the partnership and the general partner for payment of their debts.
Every limited partnership must have a general partner who remains jointly and severally liable for the debts of the partnership. In exchange for accepting personal liability, the general partner often has the right to manage the partnership and enter into contracts on behalf of the partnership.
- Limited Liability Companies (LLC)
Limited liability companies combine the traits of corporations and partnerships. This type of business structure enjoys the limited liability of a corporation and the eligibility for the pass-through taxation feature of a partnership. LLCs may also select any form of profit distribution.
In any economic climate, aspiring business owners face many challenges. Prior to starting your company, you should consult with a knowledgeable Muscatine business law attorney to find out which business structure is right for you.
Choosing the correct entity can be challenging. At Hintermeister & Kundel we do not advise clients to use a general partnership to conduct business. The general partnership has a number of significant drawbacks. Each partner has joint and several liability for the debts of the partnership. That means that if the partnership defaults on a lease or other contract, each partner is personally liable. General Partnerships can have other problems as well. If there is no written partnership agreement, it may be difficult to determine (a) who is a partner; (b) who is an employee; (c) how profits and losses will be split; and (d) who has authority to bind the partnership by signing a contract or invoice. General partnerships are often the result of an informal arrangement among business colleagues. Without proper documentation, a general partnership can be a source of litigation and frustration.
If you are currently operating as a general partnership, we urge you to obtain competent and experienced counsel. More specifically, in most cases we would attempt to restructure the partnership and transform it into a limited liability company. A limited liability company can have the same tax treatment as a general partnership. However, the LLC shields each member from personal liability as a corporation does. The LLC is the preferred entity choice for most small businesses. LLCs have the liability protections of corporations and the tax flexibility of partnerships.
TYPES OF CORPORATIONS
What is a C Corporation? What is an S Corporation? The terms S and C deal with tax issues and are very significant for the entrepreneur. A C corporation is simply a corporation established pursuant to state law that elects to be taxed under Subchapter C of the Internal Revenue Code.
What does that mean? A C corporation is taxed like an individual. Every year it must prepare a tax return and pay corporate income tax on its net income. Net income is what is left after all expenses are paid. This means that the corporation’s income is subject to double taxation – once at the corporate level and, if the corporation pays a dividend, at the individual level.
What is an S corporation? An S corporation is simply a corporation established pursuant to state law that elects to be taxed under Subchapter S of the Internal Revenue Code. Instead of paying taxes itself, an S Corporation distributes its income or losses to its shareholders who then list that income on their tax returns. The S corporation is very popular because if the corporation loses money, each shareholder can deduct a proportionate share of the loss on his or her tax return. This is not possible with a C corporation.
One more thing: every corporation starts out as a C corporation. You can elect to become an S Corporation if your corporation is eligible and if you file the correct tax election with the Internal Revenue Service. It is very important to think these tax issues through thoroughly before you begin your business. However, even if did not do any thinking before you plunged into business, we may be able to help you by restructuring the business.
For someone setting up a business, it is highly unlikely that Hintermeister & Kundel would recommend the use of a C corporation or a General Partnership. The C Corporation is not a good option because the owners cannot deduct any losses on their personal income tax returns. They are subject to double taxation, which can be enormous. The corporate tax rate can exceed 30%. The S corporation avoids the double taxation problem of the C corporation, but it is not as flexible as an LLC.
Thus, for the vast majority of businesses, John and Steve would recommend the use of a limited liability company or an S corporation.
THE OPERATING AGREEMENT
Every LLC needs an operating agreement. The operating agreement is an agreement by the members of the LLC, which sets up the basic rules for the governance of the business. An LLC without an operating agreement that is signed by each member is a weak and ineffective business organization. An operating agreement should set forth (a) who manages the LLC (will the LLC use a manager or will the members manage the LLC); (b) how distributions are made; (c) how disputes are resolved; (d) whether and when a member’s interest can be purchased by another member; (e) under what terms can a person who inherits an LLC can become a member; (f) whether the LLC can require additional capital from members; and (g) many other issues. Please note that the more people are members of the LLC, the more important the operating agreement becomes.
If you formed your LLC and did not execute an operating agreement, we can help you. We can meet with you and draft an appropriate operating agreement that meets your needs.
KNOWLEDGEABLE ADVICE FOR SMALL BUSINESSES
With more than 60 years of combined experience practicing business law, the business lawyers at Hintermeister & Kundel are here to assist you in starting your business. To schedule a consultation with a professional business formation attorney contact us
today at 563.272.0003.