All new businesses are required to register with their respective state agency, such as the State Corporation Commission (SCC) in Virginia, Department of Consumer and Regulatory Affairs (DCRA) in the District of Columbia, or the State Department of Assessments and Taxation (SDAT) in Maryland, but not all business entities are alike. It is important to understand the differences between them so that you can choose the best option for your needs.
At least three primary factors distinguish businesses entities from each other: the means of ownership, scope of liability, and taxes.
A stock corporation is a legal entity owned by its shareholders, who elect a board of directors to represent their interests. In turn, the board of directors elect officers to manage the day-to-day operations of the business. Because stock corporations are authorized to sell shares, they are a good choice for businesses that need significant capital. They also protect directors, officers, and shareholders from personal liability if the corporation is sued. But these benefits require corporations to invest more work in procedural issues like drafting and adopting bylaws, holding elections for officers and directors, and filing annual reports. Furthermore, corporations are often referenced as “double taxation” entities, where the corporation is taxed at the corporation tax rate, and then any dividends passed through to the shareholders are taxed at their individual personal income rates.
If you want the legal protections of a corporation but not the obligations to shareholders, a limited liability company, or “LLC,” may be a good option. Like a corporation, an LLC is a distinct legal entity that protects against personal liability. But instead of shareholders, an LLC is owned by at least one member, who all share in the profits and losses of the business. And although an LLC is bound by some procedure—namely its operating agreement, which is drafted and signed by the member(s)—it is more flexible than a corporation. An additional advantage of an LLC is that it is considered a “pass-through entity” which means that all profits are paid at the individual owners’ personal income tax rates. An LLC can also be taxed as a “S-Corporation” (which is not a business entity, but rather a tax designation), which will allow for the business entity to engage in savings against specific taxes, but this designation comes with its own specific restrictions and administrative requirements.
An alternative business entity arrangement, ideal for a few business partners with a common vision, is a limited liability partnership, or “LLP.” Though not as flexible as an LLC (an LLP must have more at least two partners and cannot be taxed as a corporation), it shares many of the same benefits, including a simple governing agreement and personal liability protection. LLPs are a common choice for professional businesses like law and accounting firms. However, a professional business may instead register as a professional limited liability company (PLLC). Like an LLC, a PLLC is operated by its members, but differs in two important ways. First, at least one of the members must be licensed in the business’s profession, and second, liability protection by PLLCs does not extend to malpractice.
But choosing the right business entity for you is only the first step. Let us at Kondori & Moorad guide you through the filing process and help you draft stable governing documents that will protect your business as it grows.