One major decision that every business owner must make is to decide which entity type to use to form their business. There are many entity choices to consider, some with better protections than others. This article aims to provide a general summary of the most common entity types available in Minnesota, along with a brief explanation on how to form each type. While this article provides a basis, it does not attempt to cover every detail, and you should always consult with an attorney and an accountant when deciding on and forming your business entity.
A sole proprietorship is the default business entity for an individual who operates a business and does not file anything with the Minnesota Secretary of State. This is the least complex entity type to form and maintain; however, it does not come with any liability protection for the owner of the business. That means that the owner is personally liable for all debts and obligations of the business. A sole proprietorship is a pass-though entity, which means that the business itself is not taxed at the entity level and the owner must report all business income and losses on their own personal income tax return.
A partnership involves two or more legal persons who own and operate a business together. Similar to sole proprietorships, all partnerships are pass-through entities for tax purposes. There are multiple different types of partnerships, all ranging in complexity. The four different types of partnerships are: (1) general partnerships; (2) limited partnerships; (3) limited liability partnerships; and (4) limited liability limited partnerships.
- General Partnership
A general partnership involves two or more owners who share equally in the responsibility of managing the business. It is the default and least-complex type of partnership, which is automatically formed when two or more owners operate a business together without filing anything with the Secretary of State. Similar to a sole proprietorship, each partner has full personal liability for the obligations and debts of the partnership.
- Limited Partnership
A limited partnership has two types of partners: general partners and limited partners. A general partner maintains the responsibility of managing the business, and is also personally liable for all of the debts and obligations of the partnership. A limited partner, on the other hand, does not participate in the every-day management of the business, and has limited liability for the debt of the partnership. To form a limited partnership, the partnership must file a certificate of limited partnership with the Secretary of State, and file an annual renewal to keep the partnership in good standing.
- Limited Liability Partnership
A limited liability partnership is similar to a general partnership, except that it has limited liability for each partner. As with a general partnership, there is only one type of partner – general partners. To form a limited liability partnership, the partnership must file a statement of qualification with the Secretary of State, as well as file an annual renewal each year.
- Limited Liability Limited Partnership (LLLP)
A limited liability limited partnership is the most complex partnership. It is similar to a limited partnership, except that both general and limited partners have liability protection. An LLLP is usually comprised of one or two general partners, who run the day-to-day business, and multiple limited partners who act as silent investors. This entity type is mostly used in businesses involving silent investors, who want to make a profit and have liability protection, while not taking place in the day-to-day management of the partnership. To form an LLLP, the partnership must file a certificate of limited partnership and clarify that it intends to be an LLLP, and then file an annual statement yearly thereafter.
Limited Liability Company (LLC)
Limited liability companies are one of the most popular and flexible entities, taking the best of both worlds from corporations and partnerships. The members (owners) of an LLC generally have liability protection against the debts and obligations of the company. To form an LLC, you must file articles of organization with the Secretary of State, and file an annual renewal thereafter. In setting up your LLC, there are many choices to be made – including choosing the management structure and tax status. For the management structure, an LLC can be member-managed, manager-managed, or board-managed. A member-managed LLC will have the least complex management structure, where the LLC is managed by the members of the business. In comparison, manager-managed and board-managed structures are more complex, and the business will be managed by elected managers or board members, similar to how a corporation is managed. In determining the tax status of your LLC, you can choose to either be taxed as a pass-through entity (the same as how a partnership is taxed) or as a corporation, where your LLC will be taxed at the entity level instead of “passing through” to your personal tax return. There are many pros and cons to being taxed in these different ways, and you should always consult with an attorney and an accountant before deciding the tax status for your LLC.
Corporations are the most complex and expensive entity type, but have a high degree of liability protection. Corporations are owned by shareholders, and are operated and managed by officers and a board of directors. There are many checks and balances within a corporation, often requiring certain conditions to be satisfied before the business may take any action. To form a corporation, you must file articles of incorporation with the Secretary of State, and file an annual renewal to keep the corporation in good standing. Similar to an LLC, and depending on how many shareholders there are, a corporation can select to be taxed as a c-corp or an s-corp. The differences between being taxed as a c-corp versus an s-corp are highly complex and require an extensive conversation with an attorney and an accountant in deciding which to choose.
All in all, there are many issues to consider and choices to be made when determining which entity type is the right choice for your business. As stated in this article, always consult with an attorney and an accountant in making this decision. By learning about your specific business and what you hope to achieve in the future, we can assist in choosing the correct entity type that fits your business venture.
Caitlin Crowl is an attorney with Fryberger, Buchanan, Smith & Frederick, P.A., practicing in the areas of Business, Real Estate, and Municipal Finance. This article is not intended to provide legal advice. You should always consult with an attorney about your specific circumstances.