Choosing the corporate structure for your company is one of the first steps you will take when starting a new business. There are four most common structures, and each one has advantages and challenges in terms of tax and liabilities, and management possibilities.
If you are in doubt about how to organize the administration of your company in North American territory, here are some details about Limited Partnership, Corporation, Limited Liability Corporation (LLC), and Limited Liability Partnership.
Please notice: only a good talk with a certified public accountant (CPA) will give you all the details about these structures and help you accomplish everything that you plan for your company. So be sure to seek the guidance of our consultants before making a decision.
A Limited Partnership is a form of society that must have at least one general partner and at least one limited partner—that is, at least one of the partners has unlimited liability, and at least one of them has limited liability. There is no restriction on the number of members in a limited partnership.
The advantages of a Limited Partnership include:
- Tax benefits: the profits and losses in a Limited Partnership are distributed from the company to the partners, who are taxed in their statements as individuals. Limited liability partners participate in this distribution, but do not need to participate in the management of the company itself.
- Limited liability: the participation of a limited liability partner is restricted to the amount of money they have invested in the partnership. So, creditors cannot take the personal property of the limited liability partner.
- Unlimited liability partners in charge: members with unlimited liability (that is, general partners) deal with day-to-day operations and responsibilities and do not need to consult limited liability partners to make most decisions.
The challenges of a Limited Partnership, in turn, are:
- Personal risk: the general partner takes all personal risk. So if there is any lawsuit against the company, the unlimited liability partner will answer for the company, and their personal assets may be confiscated to settle disputes. Even if the general partner has done nothing wrong, they may be personally liable in some cases.
- Shared responsibility: each general partner has the power to make decisions on behalf of the company, and such decisions are immediately the responsibility of all members of unlimited liability.
- Change of status: if a limited liability partner actively participates in the management of the company, they automatically become a partner with unlimited liability.
Corporations (also called Corp., Inc. Corporation and Incorporated, among other state variations) may have an unlimited number of partners who are also shareholders. These partners share the responsibility according to the quotas they hold in the company.
C-Corps are the standard model of Corporations, and the S-Corp are structures that require the participation of North American partners in the company. The advantages of C-Corps include:
- Protection: considering that a C-Corp is an entity that is completely separated from its partners and shareholders in legal aspects, they can’t be directly held liable or respond to possible lawsuits on behalf of the company. In other words, their personal assets will not be affected by the company’s actions.
- No taxation as an individual: a C-Corp is an individual entity, so the company’s profits and losses are retained in the company. Unless you or the shareholders receive the dividends, no member will be taxed as an individual on the income of the company. In addition, you can deduct operating expenses and labor obligations in your statement.
- Credit facility: a Corp allows for obtaining credit on behalf of the company—and this is true even for foreigners.
Now considering the points to be taken into account, the following situations should be borne in mind:
- Higher costs: corps have to pay several state and federal fees, and each state has a different set of regulations. Dealing with these specificities can be quite confusing, so the guidance of a CPA is essential.
- More bureaucracy: a larger and more complete set of rules require the company to prepare a higher number of documents before it can start operating.
- Double taxation: the owners of corps pay double taxes on company earnings, and shareholders are taxed on the dividends they receive. However, if the owners choose to receive a salary, the company is not taxed on that payment, as they will be considered business expenses.
Limited Liability Corporation
In a Limited Liability Corporation, the liability of partners is limited to the value of their shares. The profit is taxed and paid by the company, and the dividends are taxed and paid by the partners. A great advantage of this structure is that they allow for passthrough taxation, so there is no double taxation (as it happens with C-Corps).
Other advantages include:
- Single taxation: the profits of an LLC are taxed only once, at the individual level. This is a great advantage that LLC has over corps, for which there is taxation at both the individual and corporate levels.
- Taxation options: An LLC can choose whether it wants to be taxed as proprietorship, partnership, S-Corporation or C- corporation.
- Less compliance issues: although the LLC has to submit a Business Agreement to the state in which it operates, thus creating terms and rules for the company, it still has a more flexible management structure that easily adjusts to the needs of the operation and the owner(s). Proof of this is that in most states an LLC does not need to hold an annual meeting or have an administrative board.
However, there are also some points that require your attention in this model:
- Tax as passthrough: although LLCs are not subject to double taxation, they may be taxed as passthrough, which means that the company’s profits and losses are part of the personal tax return of the owners or shareholders, irrespective of whether the shareholders receive dividends or not. Because of this, the LLC structure primarily benefits individual owners, since shareholders may lose out on such taxation.
- Additional taxes: some states, such as California, New York and Texas, require LLCs to pay a fee called Franchise Tax—which, despite the name, is not related to franchises—or Capital Values Tax.
- Less structure: the lack of a requirement for tighter governance may mean problems in the future if there is not a very clear operating agreement in place, which requires an additional initial cost of negotiating and formalizing the agreement.
Limited Liability Partnership
In this model, in which two or more partners manage the company according to the social contract, the responsibility and the taxation are proportional to the value of their quotas. In this sense, an LLP is similar to a partnership, except that the partners are not personally liable for negligent acts committed by other partners or by employees who are not under their supervision.
The LLP is a widespread business structure. Here are some reasons for this popularity:
- Flexibility: partners have the authority to decide how they will individually contribute to the operations. This way, the managerial assignments can be divided equally or decided according to the experience and the interest of each one involved.
- Number of partners: there are no limits to the number of members involved in an LLP. This is a very interesting advantage if we consider that a large number of partners “spreads” responsibility over the company if something does not go as planned.
However, there are some counterpoints worth discussing:
- Not a valid model for all activities: in the states of New York, California, Oregon, and Nevada, only lawyers, architects, accountants, and some other professional categories may form an LLP.
- Additional taxes: most states impose heavy taxation on LLPs. These fees may appear in the form of additional taxes in the process of opening a business or as issues related to personal income tax.