Choosing a Business Structure

By Norman D. Roussell, MBA

In order to build business credit you must first create a formal business structure.  A formal business structure is defined as a corporation, limited liability company (LLC), or similar structure that is licensed to do business in its home city, county, state, and any other jurisdiction in which it conducts business. A formal business structure does not include operating as a sole proprietorship for one reason- asset protection.

Asset protection helps protect business assets from loss due to creditor judgments and lawsuits. The principle of asset protection is simple. A creditor can seize assets owned by a debtor, but cannot seize assets that are not owned by the debtor.

In a sole proprietorship, the business and the owner are considered a single entity. The owner, or debtor, owns the assets of the business and therefore a creditor can seize the assets of the business (i.e., assets of the owner) including the owner’s personal assets if the debt exceeds the value of the assets of the business alone. 

In a corporation or limited liability company, the assets are owned by the entity because the entity is considered separate and distinct from the owner, making it very difficult to seize the entity’s assets. 

I will not delve into asset protection in detail, as it is outside the scope of this article. I just want to emphasize that a formal business structure will improve your ability to protect your personal and business assets in the event your business is party to a creditor judgment or lawsuit.  

Alternative Business Structures

The following section briefly describes some of the basic facts, benefits, and drawbacks of different formal business structures. Keep in mind that every formal structure described may not be available in your state or recommended for your industry. If necessary, consult an attorney or qualified professional to discuss the structure that is best for your business.

• You are not required to file Articles of Incorporation or Articles of Organization to establish your business as a sole proprietorship;
• The owner and the business are considered one entity;
• There is no distinction between the personal and business assets of the owner;
• Because there is no distinction between the personal and business assets of the owner, all of the owner’s assets can be seized due to creditor judgments or lawsuits;
• If the owner conducts business under a trade name (e.g., John Doe doing business as John’s Plumbing), the business owner must register the business name with the appropriate local or state agency;
• A sole proprietorship is the riskiest form of operating a business because it does not provide the owner any asset protection against creditor judgments or lawsuits; and
• The owner has overall management responsibility for the business.

A sole proprietorship is not a recommended business structure for building business credit.

C-Corporation

•  A C-corporation is created by filing Articles of Incorporation;
• The corporation is owned by shareholders (also known as stockholders);
• A corporation can have an unlimited number of shareholders;
• A corporation can have multiple classes of stock;
• Ownership in a corporation is easily transferable from one shareholder to another;
• The corporation is a separate and distinct entity from the shareholders so shareholders are generally not held personally liable for the corporation’s debts;
• A corporation provides asset protection for the owners;
• A corporation is taxed on its earnings at the corporate level and shareholders are taxed on their share of ownership (double taxation);
• Bylaws set forth how the corporation is to be managed;
• The Board of Directors has overall management responsibility for the corporation; and
• Officers have day-to-day responsibility for the management of the company.

A corporation is a recommended business structure for building business credit.

Subchapter S-Corporation

• A Subchapter S-corporation is created by filing Articles of Incorporation and by filing Internal Revenue Service (IRS) Form 2553 (S-Election Form);
• A Subchapter S-corporation can have up to 100 shareholders and only one class of stock;
• Shareholders pay taxes based on their share of ownership at their personal Federal income tax rate (single taxation);
• The Subchapter S-corporation is considered a separate entity from the shareholders so shareholders are generally not held personally liable for the corporation’s debts;
• Bylaws set forth how the Subchapter S-corporation is to be managed;
• The board of directors has overall management responsibility for the Subchapter S-corporation; and
• Officers have day-to-day responsibility for the management of the Subchapter S-corporation. 

A Subchapter S-corporation is a recommended business structure for building business credit.
 

•  A Limited Liability Company (LLC) is created by filing Articles of Organization and filing IRS form 8832 to inform the IRS how the entity will be taxed[1];
• A LLC is owned by its members;
• A LLC can have an unlimited number of members; 
• Members pay taxes based on their share of ownership at their personal Federal income tax rate (single taxation); 
• There is generally no personal liability for business debts for the members; 
• The Operating Agreement sets forth how the LLC is to be managed; and
• A member or manager is designated to manage the day-to-day operations of the LLC.

A LLC is a recommended business structure for building business credit.

Non-Profit Corporations

• A non-profit corporation is created by filing Articles of Incorporation and making application to the IRS for non-profit status by filing IRS Form 1023;
• Bylaws set forth how the non-profit corporation is to be managed;
• The board of directors has overall management responsibility for the non-profit corporation; and
• Officers have day-to-day responsibility for the management of the non-profit corporation.

A non-profit corporation is an acceptable business structure for building business credit.

Limited Liability Partnership, Professional Corporation and Professional LLC

• Limited Liability Partnerships, Professional Corporations, and Professional LLCs are similar to a LLC or a Subchapter S-corporation, but are designed for professional service industries such as CPA firms, medical offices, architectural firms, and law offices;
• Limited Liability Partnerships, Professional Corporations, and Professional LLCs are created by filing Articles of Organization or Articles of Incorporation; and
• Shareholders, members, or partners have overall responsibility for the management of the company.

All are acceptable business structures for building business credit.

Limited Partnership

• A Limited Partnership is created by filing a Partnership Registration;
• A Limited Partnership consists of at least one general partner and other limited partners;
• The general partner is personally liable for the Limited Partnership’s debts;
• Limited partners are not personally liable, as long as they do not materially participate in the Limited Partnership’s management; and
• Partners are taxed based on their ownership percentages.

A Limited Partnership is an acceptable business structure for building business credit.

Incorporation-Friendly States: Nevada and Delaware

While it may be easy for you to set-up a corporation or LLC in your home state, there are some states that are considered “incorporation-friendly,” because of their favorable corporate and tax laws. Keep in mind that if you set-up your business in an incorporation-friendly state that is not your home state, you may be required to register your business in your home state.

Advantages of Incorporating in Nevada

• No corporate income tax;
• No corporate franchise tax;
• No tax on corporate shares;
• No capital stock tax; 
• No personal income tax in Nevada;
• No stock transfer fee;
• No succession tax;
• Nevada has no reciprocity arrangement (information sharing agreement) with the IRS;
• Minimal reporting and disclosure requirements;
• Anyone forming a Nevada corporation can remain anonymous;
• The identities of shareholders are not public record;
• Directors need not be shareholders;
• Shareholders, directors and officers need not live in or hold meetings in Nevada; and
• Corporate Federal tax payable is only 15% on the first $50,000 of net income.

 Advantages of Incorporating in Delaware 

• The Delaware General Corporation Law is the most advanced and flexible business formation statute in the nation;
• The Delaware Business Court of Chancery has written most of the modern U.S. corporation case law and is very business friendly;Delaware corporations are not subject to state corporate income tax; and
• There is no personal income tax in Delaware.

Norman D. Roussell, MBA