Types of Business Structures

Now that LLCs are the entity of choice for most businesses, corporations are used primarily for tech startups. These companies need to raise money from venture capital investors, operate stock option plans, and potentially go public, and for these reasons, the corporate structure is more appropriate than the LLC structure. In addition, because of certain tax advantages available only to corporations, it is often a big mistake for a tech startup to form as an LLC rather than a corporation.

The other situation where a corporation is used is for providers of certain professional services, such as doctors, dentists, lawyers, accountants, etc. Some states require that these types of professionals form professional corporations, rather than any other type of entity.

Limited Liability Company

The LLC is a hybrid entity. If there is only one owner (called a member), then it’s like a sole proprietorship but with a liability shield. If there are two or more members, then it’s like a partnership with a liability shield. To form an LLC, you must file formation documents, usually called articles of organization, with the state where the LLC is being formed.

LLCs are a relatively new creation. Although Wyoming first authorized LLCs in 1977, other states didn’t begin to adopt LLCs until the late 1980s, and by the mid-1990s every state had adopted LLCs. Since then, LLCs have largely supplanted the use of partnerships due to the liability shield that LLCs provide, and have become the business structure of choice for most types of businesses. LLCs provide a tremendous amount of flexibility in how they are managed, although it’s important, particularly with multi-member LLCs, to have a written operating agreement detailing ownership percentages, how decisions will be made, management responsibilities, how profits and losses will be allocated, and how profit distributions will be made. It’s also recommended to include restrictions on transfer, and provisions to deal with involuntary transfers (for example, because of divorce, death, or bankruptcy).

LLCs are pass-through entities. If the LLC is a single-member LLC, the IRS treats it as a “disregarded entity,” and the LLC and its sole owner are taxed like a sole proprietorship. The LLC itself does not pay taxes, and all revenues, expenses, profits, and losses are reported on the owner’s tax return, and taxed at that level. If the LLC has more than one member, the LLC and members are taxed like a partnership.