Definition: LLCs, Partnerships & Corporations

LLCs (Limited Liability Companies): LLCs involve two types of participants. Managers are responsible for the operation of the LLC. They do not have to own an interest in the company. Members of an LLC represent the owners of the company. Ownership of an LLC is generally expressed as a percentage interest or in terms of a specified member of units. The membership interests or units may carry with them voting rights or may be non-voting. Additionally, LLCs may be manager-managed or member-managed. As the name suggests, a member-managed LLC is a company in which all of the members (equity owners) are managers of the company. A manager-managed LLC uses a smaller group of parties as managers who are not all of the members of the company.

An LLC may choose to be taxed as a partnership or as a corporation. As such, an LLC may start out choosing to be taxed as a partnership and later elect to be taxed as a corporation, should the nature of its operations warrant it. LLCs have the advantage of providing a high degree of protection of members and managers from liability cropping up pursuant to the operation of the business or the property owned by the LLC. In addition, the creditors of a member of an LLC are limited in their ability to seize an LLC membership interest.

Finally, an LLC may have a single member. A single-member LLC may opt out of income tax reporting. Single member LLCs are very useful as the holders of investment real estate as they can protect the owner from liability cropping up from the operation of the property.

General Partnerships (GPs): A general partnership is the least protective form of partnership. Under many states’ laws, if two or more individuals undertake a business together on an informal basis, this business will be deemed to be a general partnership, regardless of whether any formalities have been undertaken to create a partnership.  All of the partners will have personal liability for all of the partnership’s obligations.

Limited Liability Partnerships (LLPs): If a general partnership is formalized under state law, it may elect limited liability status, converting it into a limited liability partnership. This type of partnership protects the general partners from personal liability for the partnership’s obligations.

Limited Partnerships (LPs): A limited partnership has two classes of participants, general partners and limited partners. General partners are responsible for the day-to-day operation of the business of the partnership, and have personal liability for the partnership’s obligations. Limited partners may not be involved in operations of the partnership and are restricted in the decisions that they are entitled to make by the partnership agreement, and therefore do not have personal liability for the partnership’s obligations. Both the general partners and the limited partners have an ownership interest in the partnership.

Limited Liability Limited Partnerships (LLLPs): A limited partnership may opt for limited liability treatment to protect its general partners. This protects the general partners from personal liability due to the operation of the partnership. Under the laws of most states, a limited partnership may register to take advantage of this limited liability status, thereby becoming a limited liability limited partnership.

Family Limited Partnerships (FLPs): There is actually no separate legal entity known as a “family limited partnership.” This title is utilized to describe a planning technique frequently utilized by families in order to make gifts of interests to junior family members while retaining control over the assets of the partnership. A family limited partnership may be a limited liability company or a limited liability limited partnership.

Under this strategy, family members contribute one or more assets to the partnership, specifying that the general partners or managers have management authority over these assets. Each contributing partner receives a partnership interest equal in value to their contribution. This approach is particularly useful in multigenerational scenarios. Parents contribute the initial capital to the partnership, receiving back general partnership and limited partnership interests. After the formation of the partnership, parents can then make gifts of limited partnership interests or non-voting membership interests in an LLC to junior family members. In this way, equity in the partnership is transferred to family members without loss of control over the management of partnership property.

Corporations: A corporation is formed by filing the appropriate documents with the Secretary of State in the state where the corporation is located. Corporations have three basic groups of participants. Owners of the corporations are known as the shareholders or stockholders. They elect the Board of Directors, which is the second group of participants and responsible for the general oversight and governance of the corporation. The Board of Directors is accountable to the shareholders regarding the management of the corporations and its profitability. The Board of Directors elects the officers of the corporation, the third group, which includes the President, Vice President, Secretary and Treasurer. Many states have simplified their corporate laws and now only one officer, the President, is required. The officers are accountable to the Board of Directors regarding the day-to-day management of the company and its profitability. In order for a corporation to pay out its net profits (profits remaining after all expenses, including compensation, have been paid) to its shareholders, it must declare and pay dividends.

The classic type of corporation is often referred to as a C corporation and represents a separate taxable entity. C corporations pay income tax at corporate rates on their net profits. After-tax profits are then distributable to the shareholders as dividends. C corporations result in taxation of the profits of the corporation at two levels, the first being at the corporate level and the second as dividend income taxable to the individual shareholders. There is another type of corporation known as a Subchapter S corporation. This type of corporation is ignored for federal income tax purposes and is frequently utilized for startups or small businesses. The profits of an S corporation are taxable to the shareholders (not the corporation) regardless of whether those profits are distributed. Each shareholder picks up taxable income based upon their percentage interest in the corporation.

As a form of business entity, corporations are very well understood and their attributes have been thoroughly defined by the courts.  Legally, a corporation is usually considered to be separate from the people who own it, thus protecting the shareholders from liability. A concept referred to as the corporate veil protects shareholders, Boards of Directors and officers from personal liability as long as certain criteria are met. There is a well-developed body of law as to when it is justifiable to “pierce the corporate veil.”

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Business Formation, Entity Selection and Reorganization