When you start your own San Diego small business, you have several types of corporate entities through which to operate. In this article, we discuss the key differences between three commonly used entities: general partnerships, standard corporations, and limited liability companies (“LLCs”). All three types of business entities are legal under California statutory and case law. To determine which form is best for your business, it is essential for you to retain an experienced San Diego corporate attorney to provide advice and counsel.
A partnership is a combination of persons who agree to engage in a business venture and agree to split the profits (or losses). The owners are the partners. A partnership does not provide any personal liability shield if debts and/or obligations are collected by creditors. Under a partnership, each partner can be responsible for the whole of the partnership’s debts. Management of the partnership is generally done collectively by the partners or, sometimes, by a partner appointed/elected by other partners. However, all partners have the ability to bind the partnership via contract or in other ways.
In terms of taxation, a partnership is what is known as a “pass-through” entity. That is, there is no taxation at the partnership level; all taxes are “passed through” to the partners to be taxed via individual income tax returns. At an individual level, salaries, wages and profit distributions are all taxed as “income” taxes. This tax treatment is one of the main advantages of forming a partnership. Other advantages include ease of formation and almost no legal formalities in terms of how the partnership operates day-by-day and annually.
Unlike a partnership, a corporation must be formally created by the filing of Articles of Incorporation with the California Secretary of State’s Office, adopting Bylaws, holding board and shareholder meetings, issuing securities, obtaining a tax ID number, and other formation actions. Partnerships can be formed via a handshake agreement (although that is not recommended). Corporations cannot exist at such a level of informality. The owners of a corporation are called shareholders. In general, one share entitles a shareholder to one vote and a proportional share of any profit distributions. Generally, the right to profit distributions is based on the amount invested. The general operation of the corporation is undertaken by the board of directors. Directors are elected by the shareholders. The day-to-day operation of the corporation is done by senior management employees such as the President of the corporation or the Chief Executive Officer. A corporation is the most commonly used business entity that provides a liability shield for personal assets. That is, if the corporation defaults on its debts, the corporation’s creditors are generally limited to collecting the debts from the assets of the corporation. The personal and family assets of the owners are shielded. Typically, only officers can bind the corporation to contracts (with the authorization of the board of directors, when required). Shareholders are limited to obtaining a return on their investment and electing members of the board. To maintain a corporation in “good standing,” there are many formalities that must be undertaken annually, such as regular meetings of the shareholders, annual meetings of the board of directors, maintaining the corporate minute book, and filing a Statement of Information with the California Secretary of State. In term of taxation, corporations are taxed at the corporate level, but S-Corporations are pass-through entities where most taxes are paid by the shareholders.
Limited Liability Companies
Like a corporation, an LLC must be formally created by the filing of Articles of Organization with the California Secretary of State’s Office, adopting an Operating Agreement among the members, possibly appointing managers, issuing membership interests, obtaining a tax ID number, and other formation tasks. An LLC cannot exist informally. The owners of an LLC are called members. Unlike a corporation where an owner’s share of the profits is linked to percentage share of ownership and paid-in capital, an LLC is free to distribute its ownership percentages without regard to capital contributions and the Operating Agreement can specify how profits are distributed. LLCs are operated by their Managers. Managers can either be members of the LLC or can be hired by the members in the manner of how a corporation can hire a President. Like a corporation, an LLC provides a shield that protects the personal assets of the owners. LLCs have some flexibility with respect to taxation. The “default” position is that an LLC is taxed as a partnership, but the LLC can choose to be taxed as a corporation. For the State of California, regardless of the choice with respect to federal taxation, LLCs must pay annual franchise taxes.
As noted, these are just some of the key differences among business forms. Consult with a trusted San Diego corporate attorney for additional details on the best form for your unique business needs.
Contact San Diego Corporate Law Today
For more information, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides a full panoply of legal services for businesses and corporations. Mr. Leonard can assist with the formation of your California professional corporation and any other business entity — corporations, LLCs, and other forms. Mr. Leonard can also assist with sales, mergers and acquisitions, contract drafting and review including commercial leases, and establishment and licensing of trademarks, copyrights, and trade secrets. Mr. Leonard can be reached at (858) 483-9200 or via email. Like us on Facebook.