On planning a business one of the first important decisions any promoter has to take is about the structure of the business. Commonly available business structures are sole proprietorship, partnerships, limited liability corporations, and a corporation. In this write, a comparative study of the structures of the corporation, limited liability corporation, and partnership is undertaken to help us in undertaking a decision for a new business. Partnerships under consideration are general partnerships, and a corporation we are deliberating is C. corporation. However, a business should be structured depending upon several factors like the nature of business, individual liabilities, status as per tax laws in the country, and other factors. The main consideration deliberated here is legal formalities for setting up the structure, liabilities of the promoters, and tax status.
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Minimum two persons are required to formulate a partnership but the partnership has no legal status without the partners. The corporation is an artificial legal person and it has perpetual life. A limited liability corporation (LLC) is also created as a corporation to limit the liabilities of its members. The partnership needs a partnership deed for its constitution. However, there can be oral partnerships as well. To incorporate a corporation and an LLC, promoters have to procure a name and file certain documents like memorandum of association, articles of association, and a declaration from an authorized professional about compliances of required legal formalities. There may be certain restrictions to the upper limit of members in a partnership concern and an LLC as per relevant laws, but no such limit is there for the members or shareholders of a corporation.
Normally the owners of an organization are responsible for its debts and actions. In the case of a partnership, this liability is unlimited whether the partner is active or not. Recoveries can be made from the personal properties of any partners when the properties of partnership are insufficient to meet the liabilities. In a corporation, the liability of a member is limited to the face value of shareholding the member has undertaken to subscribe. The member is liable for the unpaid amount only. The directors of the corporation are, however, responsible for the acts and omissions of the business and also for the debts of the corporation. But this liability of the directors is again restricted as per the provisions of the contract of their appointment with the company. The liabilities of the members of an LLC are similar to a corporation. That is to say, they are liable to pay only the unpaid of their subscription.
Corporations are doubly taxed on their earnings. First, the corporations pay corporation tax on the taxable income, and then the members have to pay taxes on the dividends or other distributions they receive from the corporation. However, partnerships and LLCs have to pay taxes only once on their earnings. Distributions to partners or members are tax-free. But partnerships and LLCs are liable for self-employment tax. On the other hand shareholders of a corporation need not pay self-employment tax. This is because corporations have been made to pay unemployment tax Similarly, “the liquidation of a corporation can have adverse tax consequences in addition to gain recognition” (Steven C. Alberty, 2005, page 145)i.
The structure decision mainly rests with the size of the business and the extent of liabilities the members are ready to undertake.
i Steven C. Alberty, 2005, Limited Liabilities Companies, ALI-ABA.