Does the Shoe Fit? Key Considerations in Picking the Proper Business Model to Suit Your Needs*
For those who are in the process of forming a new business, or those that are pondering the idea of revising a pre-existing business model, choice of entity is an important administrative decision with real-life consequences. The entity type chosen for your business affects everything from the ownership and control, to the potential for tax and financial liability, to succession planning.
Below is a list of the primary attributes of Wisconsin business organizations as well as some key considerations to keep in mind during the decision-making process:
(1) Sole Proprietorship
Sole proprietorships are the easiest entity type to establish and consist of a single owner and operator. The business simply functions as the “alter-ego” of the owner rather than its own separate and distinct legal entity. For this reason, there is no separate entity for tax and liability purposes. Sole proprietors are personally liable for all debts incurred in conducting business and are personally taxed for income generated by the business. Sole proprietorships are terminable upon death of the sole proprietor.
(2) General Partnership
General partnerships consist of two or more general partners who transfer personal assets to the partnership. There is no requirement for establishment of a general partnership to be in writing; however, it is highly recommended that general partners reduce the terms and conditions of their partnership to a written agreement. General partnerships are managed by the partners themselves and terminate after the period dictated in the partnership agreement or until one of the partners ceases to be associated with the partnership. Partnership interests are transferrable to others, but transferees do not become “partners” absent the consent of the other members of the partnership. General partners are jointly and severally liable for indebtedness of the partnership. General partners owe one another fiduciary duties and may be held liable for any material breaches of those duties.
(3) Limited Partnership (LP)
Limited partnerships consist of at least one general partner and one or more limited partners. The general partner is responsible for the day-to-day decision-making for the business while the limited partners are unable to participate in the business operation. They are simply passive investors. The general partner(s) have unlimited personal liability while the limited partner(s) are only liable for losses up to their original investment in the LP. LP’s are not taxed as separate entities, and income or loss “flows through” to the general and limited partners in proportion to their percentage of shares in the profits/losses.
(4) Limited Liability Partnership (LLP)
Limited liability partnerships are variations of general partnerships that are often used in professional practices (lawyers, accountants, etc.). All members of an LLP are considered general partners and can actively participate in control of the business. To establish an LLP, a general partner must file a registration statement with the Wisconsin Department of Financial Institutions (WDFI). Partners in an LLP are held personally liable for their own wrongful or negligent acts but are shielded from liability for the wrongful or negligent acts of other members in the professional partnership. LLP’s are not taxed as separate entities, and income or loss “flows through” to the partners in proportion to their percentage of shares in the profits/losses.
(5) Limited Liability Company (LLC)
Limited liability companies are hybrid business organizations that provide the benefit of limited liability and centralized control while being taxed in the same “pass through” manner as partnerships or S-Corporations. In Wisconsin, all LLC’s are subject to the Wisconsin Limited Liability Company Act. In order to formally establish itself, an LLC must file Articles of Organization with the Wisconsin Department of Financial Institutions (WDFI). LLC’s remain in existence for the duration specified in their Articles of Organization. Management is carried out by elected managers of the LLC, who do not necessarily have to be members or investors. Profits and losses generated by the LLC are apportioned on the basis of each member’s percentage of their capital contributions to the LLC at the time of its establishment, or added thereafter.
A C-Corporation is a conventional business corporation with officers and directors responsible for control and management of the business and shareholders responsible for initial and continuing investment capital in the business. In order to establish a C-Corporation, an officer or director must file Articles of Incorporation with the Wisconsin Department of Financial Institutions (WDFI). The corporation is considered to be a separate entity for all tax and legal purposes. This means that the corporation itself may own and maintain property, can sue and be sued, enter into contracts, and incur debt. Generally speaking, shareholders are not held personally liable for the actions of the corporation. The exception to this rule is known as “piercing the corporate veil.” This rare exception occurs when shareholders, officers, or directors fail to observe corporate formalities, use the corporation as their alter ego, inadequately capitalize the venture, or otherwise do business in a way that the separate identities of the two become sufficiently intermingled.
An S-Corporation retains many of the same characteristics of a C-Corporation except that its management elects to be taxed under Subchapter S of the Internal Revenue Code (IRC). In order to be eligible for taxation under Subchapter S, the corporation must (a) be a domestic corporation; (b) not be a member of an affiliated group or a prohibited corporation (financial institutions, insurance companies); (c) have a maximum of 100 shareholders; (d) have shareholders that are only individuals or qualified trusts; (e) have no non-resident alien shareholders; and (f) have only one class of stock. In order to be taxed as an S-Corporation, an election must be filed on or before the 15th day of the third month of the taxable year.
(8) 501(c)(3) Charitable Organization
A 501(c)(3) organization enjoys tax-exempt status pursuant to Chapter 501(c)(3) of the Internal Revenue Code. Pursuant to Wis. Stat. § 202.11(2), a 501(c)(3) organization must have a “charitable purpose” consisting of “a benevolent, educational, philanthropic, humane, scientific, patriotic, social welfare, advocacy, public health, environmental conservation, civic, or other eleemosynary objective.” 501(c)(3)’s may solicit contributions but must take special care to avoid generating substantial revenues from ancillary business ventures which could potentially negate their tax-exempt status under the Internal Revenue Code.
(9) Joint Venture
Unlike the above-mentioned business organizations, joint ventures are not legal entities established by the Wisconsin Statutes. Rather, joint ventures are contractual agreements whereby two or more persons join together for a common business objective. The duration of a joint venture is specified in the contract between the parties and can be extended by further agreements. It is imperative that joint venture agreements be reduced to writing, detailing the individual contributions to be made to the venture, sharing of the profits and losses, as well as the allocation of control over the day-to-day operations. For purposes of taxation and liability, joint ventures are treated much the same as a partnership.
The formation or revision of your business entity will impact your livelihood in many different ways. For this reason, you should engage in reasoned decision-making with the help of an experienced attorney prior to establishing your business. John M. Kelly, Attorney at Law, LLC is home to over 42 years of experience in the establishment, organization, and maintenance of every type of business entity commonly used today. Call today to explore your options for your next business venture.
*General information on Wisconsin’s default rules of establishment, management, and taxability of business organizations was obtained from: 7 Kenneth B. Axe et al., The Wisconsin Business Advisor Series: Business Organizations (2006).