Choice of Business Entity (Part 2)
In Part 1, we explored doing business as a sole proprietor or in a partnership. A problem with those types of business entities was that they did not shield the sole proprietor or the general partner from the claims of creditors of the business. This installment will briefly discuss the operation of a business through a corporation or a limited liability company, two forms which, if established and operated correctly, can provide the owners with limited liability.
In a corporation, the owners (“shareholders”) generally have limited liability for the corporation’s conduct of the business. This liability is “limited” to the shareholder’s investment in the corporation. This is applicable, even if there is only one shareholder. While generally the liability is limited, the corporation must observe all the corporate formalities, such as having regular meetings of its directors and shareholders, documenting all action taken (leasing property, setting up a bank account, paying compensation and dividends to the shareholders), and owning or leasing its own property, and treat the business as a separate entity. If they fail to do so, creditors may be able to “pierce the corporate veil” and assert the liability of the corporation against the shareholders.
In a limited liability company (”LLC”) as in a corporation, the owners (“members”) generally have limited liability for the LLC’s conduct of the business. Unlike a corporation, an LLC does not have to observe formalities, such as conducting meetings and documenting the actions of the LLC. However, the members must treat the LLC as a separate entity with its own assets, including bank accounts, and liabilities.
Note that other issues may arise when selecting your choice of entity. A corporation may be either a “C-corporation” or an “S-corporation.” An LLC can be ignored for income tax purposes if there is only one member; if there is more than one member, it may be treated as a partnership. If the member(s) otherwise elect, an LLC could be treated as a corporation (C-corporation, or S-corporation). No matter what the income tax election or consequences, the income tax treatment has no effect on liability issues.
This article and Part 1 have each addressed, in general terms, the types of business entities available to the business owner. No decision should be made without considering all of the issues. Please feel free to contact us with any questions you have regarding this or any other legal issues confronting your business.
If you are starting a business or have any questions regarding the legal alternatives available to your business, please contact:
312-368-0100 or msaunders@levinginsburg.com.
