Businesses can be operated in several different forms in New York State. The choice of which form to use can have significant liability and tax implications. This article will provide an overview of the formation requirements, liability implications and tax implications of several business forms.
A business that is owned and operated by a single person is a sole proprietorship. A single person who operates a business without taking the necessary steps to form any of the business entities described below is a sole proprietorship. Sole proprietors who conduct or transact business in New York State under any name other than his or her legal name are required to file an assumed name certificate (“DBA”) in each county where he or she transacts or conducts business. The benefit of operating a business as a sole proprietorship is that the filing of a DBA is the only formal requirement to begin operating. In addition, no additional tax filings are necessary to operate a sole proprietorship. All income that is derived as a result of the operation of a sole proprietorship is reported on the sole proprietor’s individual tax return. The biggest disadvantage of operating a business as a sole proprietorship is that sole proprietors are personally liable for all debts and obligations of the business. This means that the sole proprietor’s personal assets may be used to satisfy the debts and obligations of the business.
A business that is owned by two or more individuals who conduct business without taking the necessary steps to form any of the business entities described below is a partnership. A partnership is required to file a DBA in each county where it transacts or conducts business. No other formalities are necessary to form a general partnership. However, we strongly recommend that partnerships have a written agreement regarding the operation of the partnership. The benefit of operating a business as a partnership is that partnerships provide “pass through” taxation treatment. This means that items of income, deduction and credit are passed through to the partners. The partners treat such items as personal items on their individual tax returns. This is an advantage if the partnership is producing losses, deductions or credits because such tax benefits can be used by the partners to offset income from other sources. The biggest disadvantage of operating a business as a partnership is that each partner is personally liable for the debts and obligations of the partnership.
A corporation is a legal entity that is separate and distinct from its owners. The owners of a corporation are called shareholders. A corporation is managed by its board of directors and its officers.
Corporations are taxed pursuant to either Subchapter C of the Internal Revenue Code (a “C corporation”) or Subchapter S of the Internal Revenue Code (an “S corporation”). The biggest disadvantage of operating a business as a C corporation is that the corporation’s income is taxed twice. The income of a C corporation is taxed at the corporate level and is taxed again on dividend distributions at the shareholder level. The tax treatment of an S corporation is similar to that of a partnership. An S corporation does not pay taxes at the entity level. A corporation must make a formal election with the Internal Revenue Service in order to be an S corporation. However, corporations must meet the following requirements in order to be eligible to elect to be an S corporation:
- it must have no more than 75 shareholders
- its only shareholders must be individuals, estates, certain exempt organizations or certain trusts
- it must have no nonresident alien shareholders
- it must have only one class of stock
The biggest benefit of operating a business as a corporation is that a corporation provides limited personal liability protection to its shareholders. In general, a shareholder’s liability for the acts, omissions, debts or other obligations of a corporation is limited to his or her capital contribution. However, a corporation must be properly formed and operated in order to maintain this limited liability protection.
Limited Liability Companies
The newest form of New York State business entity is a limited liability company. The owners of a limited liability company are called members. Unlike an S corporation, limited liability companies do not have any restrictions as to ownership. A limited liability company is managed by its members or by managers. The governance of an limited liability company is very flexible. This makes limited liability companies favorable for estate planning purposes.
The biggest advantage of operating a business as a limited liability company is that it provides the limited liability protection of a corporation and the “pass through” taxation treatment of a partnership. However, like a corporation, a limited liability company must be properly formed and operated in order to maintain this limited liability protection.
The biggest disadvantage of operating a business as a limited liability company is that the formation of a limited liability company is more technical and costly than the formation of a corporation. This is due in part to the requirement that a New York limited liability company publish notice of its formation once each week for six successive weeks in two newspapers. There is no publication requirement related to the formation of a corporation.
Professional Service Businesses
Licensed professionals such as doctors, lawyers and accountants may conduct their business as either a sole proprietor, a general partnership, a professional service limited liability company (“PLLC”), a registered limited liability partnership (“LLP”) or a professional services corporation (“PC”). The advantages and disadvantages of conducting business as a sole proprietor or a general partnership are set forth above. The tax treatment of operating a business as a PLLC is similar to that of a limited liability company and the tax treatment of operating a business as a PC is similar to that of a corporation. The tax treatment of operating a business as a LLP is similar to that of a partnership. All three types of entities offer limited liability protection to the owners in regard to the debts and obligations of the business. However, the owners of all three types of professional entities are personally liable for their own malpractice and for the malpractice of persons who practice their profession under their direct supervision and control.
The choice of entity for a particular business requires a case-by-case analysis, and may involve a number of factors that may not be present in all cases. This article is intended only as a general summary of some of the relevant factors to consider when selecting a business form, and any decisions made in connection with these issues should only be made after consultation with counsel.
Please contact Michael McConville, Amy Varel or Raquel Laude of our corporate/business department if you need further information regarding any of these business forms or to discuss any other business related matters.