Corporate Law Article
CCLM Law

Choosing the Right Business Structure

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Starting a new business is a stressful time. From hiring employees to determining an operating budget, there are many decisions to make in the beginning stages of the creation of your business. One of the most important decisions is choosing a business structure that’s right for you.

Choosing a business structure is important for many reasons. Your structure will determine how much you pay in taxes, filing requirements and personal liability. The four main business structures in Florida are: Sole Proprietorships, Partnerships, Limited Liability Companies and Corporations.

  • Sole Proprietorship – A sole proprietorship is the easiest business structure to form, and therefore one of the most common. This type of business entity is an unincorporated business that is owned and operated by a single individual. Some business owners choose to form a sole proprietorship while they test out a business idea. However, a sole proprietorship does not protect your personal assets from any debts or liabilities from the business. If your business includes a high-risk or inherently dangerous activity, it would be best to choose a different type of business structure, as you will be personally liable.
  • Partnership – There are many different types of partnerships: general, limited, limited liability (LLP) and limited liability limited (LLLP). General partnerships usually exists when two or more people own a business together. A disadvantage to the general partnership is the personal liability that comes with it. Similar to a sole proprietorship, co-owners in a general partnership are personally liable for the debts or liabilities of the partnership. Due to the liability that comes with a general partnership, most new business owners choose a different business structure. The various forms of limited partnerships are more advantageous. In a limited partnership, a general partner has the same rights and liabilities as in a general partnership, however, a limited partner has limited rights and liability. If forming a limited partnership, you may want to consider forming a corporation to act as a general partner to further limit the total exposure of the principals involved. A limited partnership may elect to become a LLLP. This frees general partners of the limited partnership from personal liability and leaves the partnership with the sole obligation. However, LLPs go a step farther and absolve partners in a general partnership from personal liability altogether (with exception to personal misconduct) so long as the partnership is formed as a LLP. A good way to understand this is a LLP is a general partnership with limited liability protection, compared to a LLLP, which is a limited partnership with limited liability protection.
  • Limited Liability Company – A limited liability company “LLC” is a very popular business entity and it allows business owners the benefits of both partnership and corporation structures. LLCs protect your personal assets by offering limited personal liability. LLCs also do not require the same formalities as corporations (mandatory stockholder meetings, management meetings, etc). Additionally, subject to the number of members, the LLC may elect to be taxed as a sole proprietorship, partnership or corporation. You can read more about LLCs at LakelandLaw.com.
  • Corporation – A corporation is an independent legal entity that is separate from the people managing the corporation. Offering the strongest personal liability protection, corporations are a much better choice if the business engages in a higher risk activity. While the cost to form a corporation is higher than other entities, corporations have a significant advantage in raising capital through stock sales. Additionally, corporations require more formalities such as, annual stockholder meetings, extensive record keeping and reporting.

Selecting the right business structure can be your first step toward success in creating a new business. The decision can be challenging, but consulting with a local attorney is always the best option to make sure your personal and business needs are met.

Miranda K. Martinez is a 2019 graduate of Stetson University’s College of Law and recently joined Clark, Campbell, Lancaster & Munson, P.A., in Lakeland. Questions can be submitted to thelaw@cclmlaw.com.

Tax Law Article
CCLM Law

LLC’s Electing to be taxed as S Corporation

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Limited liability companies (“LLC”) have become a popular entity for owning and operating a business. A multi-member LLC can elect to be taxed as a partnership, C corporation or an S corporation. It is common to see LLC’s elect to be treated as S corporations for federal tax purposes. An S corporation has certain limitations on the number of owners, the type of owners, and the classes of stock. This article will focus on the classes of stock limitation of an LLC electing to be taxed as an S corporation. An LLC typically does not issue stock, but rather issues membership interests to its members. The membership interests operate as stock for S corporation purposes.

Under the Internal Revenue Code, an S corporation can only have one class of stock receiving the same distribution and liquidation rights. The S corporation, however, may issue both voting and non-voting stock, and this will not cause the corporation to lose S election so long as the other rights remain the same, such as liquidation and distribution rights.

Should a multi-member LLC elect to be taxed as an S corporation, then the LLC must follow all of the S corporation requirements under the Internal Revenue Code. That is, the LLC, taxed as an S corporation, must only have members, who qualify as S corporation shareholders, no more than 100 members, and one class of membership interest.

The governing document for the management and operation of an LLC is usually governed by an Operating Agreement. Because a person may easily form an LLC online and obtain a draft Operating Agreement from the web, they do not look at the terms and provisions of the Operating Agreements to see if it does not inadvertently create a second class of stock. Most Operating Agreements found on the web or prepared by third parties are drafted in the context of partnership tax law or may include terms and restrictions on certain members resulting in a second class of stock.

For instance, the Operating Agreement may include common partnership tax language that upon liquidation, distributions will be paid to members with positive capital accounts in accordance with their respective positive capital account balance before other distributions to members. Or the Operating Agreement may have specific profit or loss allocation language. Such language may result in the LLC’s S election being inadvertently terminated because the members of the LLC do not have identical rights to distribution and liquidation proceeds as required under the Internal Revenue Code and Regulations. Therefore, the IRS will conclude that upon entering into the Operating Agreement, the LLC ceased being an S corporation for tax purposes and had become a C corporation. The loss of S corporation election will result in increased taxes, filing requirements and other limitations or potential liability, such as built-in gain tax.

To fix this inadvertent S termination and treat the LLC as an S corporation from the date of S termination, the LLC will need to formerly seek and obtain approval from the IRS to treat the LLC as an S corporation and to correct the error in accordance with the Internal Revenue Code.

We recommend that when forming or starting a business, the parties seek competent tax and legal counsel in choosing the best type of entity (partnership, LLC, S corporation, C corporation, etc.) for not only operating and managing the business, but also for the overall tax and costs benefits. Each entity has its own advantages and disadvantages. Even after you choose the type of entity, the governing documents, the Operating Agreement, need to be carefully drafted to conform to the type of business selected.

John J. Lancaster, LL.M is a shareholder with the law firm of Clark, Campbell, Lancaster & Munson, P.A., in Lakeland. Questions can be submitted to thelaw@cclmlaw.com.