Business structures are legal forms of organization of companies. The legal framework of the respective legal structure of a company is determined by laws. Each structure has certain characteristics that determine, among other things, the modalities of incorporation and participation in business life.
The legal structure of a company decides on tax obligations as well as legal and economic basis for operating. They are particularly important when it comes to establishing companies, expanding companies or merging companies.
|Basic requirements||Liability protection for debts and lawsuits||Tax status|
|Sole proprietorship||Only 1 person||Unlimited personal liability||Self-Employment and personal income tax|
|Partnerships (GP, LLP, LP)||2 or more people||Unlimited personal liability unless structured as an LP or LLP||Self-employment tax (except for limited partners), Personal income tax|
|Limited Liability Company (LLC)||1 or more people, plus professional licensing board approval and Articles of Organization if a PLLC||Owners are not personally liable||“Pass through” Self-employment/ Personal tax OR S Corp tax status- owner(s) decide|
|C Corp||1 or more people, Articles of Incorporation||Owners are not personally liable||Corporate tax rate (usually around 21%, down from 35% in 2017)|
|S Corp||1 or more people (no more than 100), all must be U.S. citizens or residents, Articles of Incorporation||Owners are not personally liable||“Pass through” personal income tax only|
|B Corp||1 or more people, Articles of Incorporation, Certification to Operate for the Public’s Benefit||Owners are not personally liable, including some exemptions from the traditional application of the business judgement rule||Corporate tax rate as either C or S corporation, plus annual B Lab fees for certification to operate for public benefit|
|Nonprofit Corporation||1 or more people, Articles of Incorporation, Charitable Purpose, or Public Service||Owners are not personally liable||No tax, but corporate profits cannot be distributed to owners|
|Cooperative Corporation||1 or more people, Articles of Incorporation, must be democratically operated for benefits of members and owners||Owners are not personally liable||Normally taxed like a corporation with possibility to deduct “patronage dividends” as pass through income tax|
We will evaluate the goals and activities of your business to meet your needs when choosing a U.S. company structure. Restructuring your business is possible later, but the best strategy is to get it right from the start.
Options and benefits will vary depending on which U.S. state you are in, so understanding the advantages and downsides of each state is critical when choosing the right business structure. Ultimately, the decision between different business entities comes down to three factors:
- The flexibility and freedom you want to run your business;
- the personal liability protection you need; and
- the tax benefits you can gain.
Here is a basic summary of each one:
Partnerships enjoy the maximum freedom and flexibility in management of the business, have the fewest regulatory compliance obligations, as well as the simplest tax structure. However, you will normally have the highest level of personal liability for the business under a partnership.
Sole Proprietorship (SP)
An SP is the most basic structure that will be the default status your business is given if you don’t register it differently. Under this structure, you have the maximum flexibility and freedom to run your business as you like with minimal regulation, but also with maximum personal liability. An SP has just one owner (a married couple is usually considered a single owner), who is personally tied to all assets and liabilities of the business, meaning they pay the individual income tax and self-employment tax at the highest rate (around 15%).
Generally speaking, an SP is considered indistinguishable from the individual owner(s). You normally must conduct business in your own name if you have an SP, but you can file a “Doing Business As” (DBA) and use a different name of our choice, including trade names. It is very easy and inexpensive to operate as an SP because there is no formal start up or registration process (aside from obtaining licenses and permits required in your business activity or profession, and the DBA) and there are very few regulations on SPs.
A German citizen can have a SP and file a DBA to in the U.S., but they will need to obtain an Employer Identification Number (EIN) or an International Tax Identification Number (ITIN), and will need an address in the U.S., which can normally be provided inexpensively through a registered agent service. Sometimes the DBA will also require a notary to validate their signature before it can be filed.
General Partnership (GP)
A GP is an association of two or more persons in an unincorporated company formed by an agreement between the owners, and again will be the default status your business is given if you do not register otherwise (if have two or more people).
Similar to an SP, the greatest advantage of a GP is simplicity, low expenses, and maximum freedom. There normally are no formal start up processes or paperwork that needs to be filed, with minimal regulations. Under a GP, all partners have equal management control of the business, share the right to use the GP property, and share the profits of the GP in predefined proportions per their agreement.
A GP will be regulated almost exclusively by the legal arrangements the partners make between themselves, giving a maximum freedom and flexibility to carry out their business activities. The downside is that all GP partners are “jointly and severally liable” for any legal actions and debts against the company, meaning that a creditor may sue any one of the partners individually (which can extend to personally owned non-GP assets) for a debt of the GP (with limited exceptions in certain jurisdictions under certain circumstances). For tax purposes, a GP, like a sole proprietorship is an extension of the partners as individuals, which carries the same tax burden.
Limited Partnership (LP)
An LP is similar to a GP, except that while a GP must have at least two general partners, a limited partnership must have at least one general partner and at least one limited partner. Under this structure the general partner(s) will assume most liability for the business, while limited partners will have liability connected to their specific role or share in the business.
LPs are often businesses that focus on a single or limited-term project, and are common for private equity companies, film production companies and real estate investment projects. Typically LPs have an arrangement where one partner contributes money for a project and the other partner performs the actual work; this is an advantage when business interests are given to many individuals because there is no additional tax liability of a corporation.
LPs are less common due to legislative changes that eliminated what was called the "control rule," which was a common practice of naming an entity that “controlled” the LP and classified all other managers as limited partners, effectively leaving no partner fully liable except for the LP itself. Most U.S. states that have adopted the legislative revisions (in 2001) that allow LPs to restructure or classify as limited liability partnerships (LLP), where debts of the partnership are solely the responsibility of the partnership, but also carry additional duties and restrictions not in an LP.
Limited Liability Partnership (LLP)
An LLP is like a GP that functions as a cross between a corporation and a partnership, which is very similar to a Limited Liability Company (LLC) because the partners have limited personal liability, usually tied to their individual work or share of the LLP.
Professional businesses such as law firms, Certified Public Accountants, or other professional services are commonly organized as an LLP because such businesses are usually prohibited from forming an LLC. An LLP (unlike an LLC) must have a managing partner(s) that is liable for the actions of the LLP.
Partners who invest money but have no official duties, called “silent partners” have liability protection in an LLP. About 40 states allow the formation of an LLP, with some states limiting what professions can form an LLP, which can affect plans to operate in multiple states, as some do not recognize a foreign LLP (an LLP formed in any other U.S. state or foreign country). LLPs and LLCs can take advantage of the 20% pass-through deduction allowing up to 20% of your business profits from your personal tax return (limitations on this complex tax break apply under different circumstances).
The different types of corporations provide lots of personally liability protection, advantageous tax structures, but also require higher startup costs, regulatory compliance and operating expenses.
C corporations offer the highest degree of personal liability protection for its shareholder-owners and executive officers, commonly called “the corporate veil.” Ownership of a C Corp is through the issuance of stock (held privately or publicly) in the company, making it the structure that is generally best suited to raise capital from investors.
Unlike most other structures, C Corporations pay a corporate income tax rate on their profits as separate entities, and then shareholders pay income tax on any profits distributed- causing the “double tax” effect. Articles of Incorporation must be filed with the Secretary of State in the state of incorporation to register, and the business must follow internal and external corporate rules to operate legally and stay in good standing with the state. The possible requirements include holding shareholder and board of director meetings, adopting bylaws, filing annual reports, among other tasks.
In some situations, the federal corporate tax rate (usually around 21%, down from 35% in 2017) is lower for corporations than for individuals (income, plus Social Security, Medicare and Medicaid), but still has the “double tax” structure. A C Corp may also be eligible for tax deductions not available to an LLC, partnership, or sole proprietorship. However you will have higher formation and operating costs to establish a C corporation due to all the registration and regulatory compliance requirements.
An S Corporation is a corporation that elects to have a business pass-through tax treatment on federal income taxes and does not pay federal taxes at the corporate rate; thus avoiding the “double tax.” Instead, all profits are reported on their personal income tax returns of the shareholder-owners.
LLCs and C Corporations may elect to be taxed as S Corporations, with all other elements remaining largely unchanged, including liability protection for owners, avoidance of double-taxation and flexibility in accounting (different from a C Corporation).
Unfortunately, an S Corporation may have no more than 100 shareholders (which impacts growth potential), and shareholders must be U.S. based entities or individuals who are either United States citizens or permanent residents. Electing to have an LLC or C Corp taxed as an S Corp can result in additional upfront costs, along with reports and other formalities to stay compliant with the law.
Close corporations (also called a “closely held corporation”) are non-public corporations which have fewer than the required number of shareholders to require being listed as a public corporation. The main benefit of a close corporation is that it will be exempt from many regulations of corporations as far as structure, record keeping, accounting, and disclosures.
Shareholders of a close corporation can participate in the daily operations of the business similar to a partnership, but they still have liability protection. Normally close corporations must not be publicly traded, and must have fewer than 35 shareholders, though this depends on each state's unique laws.
Benefit Corporation (B corp)
B corporations are for-profit corporations driven by both mission and profit, where shareholders hold the company accountable to produce some sort of public benefit in addition to a financial profit. B corps are different from C corps in purpose, accountability, and transparency, but aren't different in how they're taxed. Some states require B corps to submit annual benefit reports that demonstrate their contribution to the public good.
Nonprofit Corporations are corporations established to do charity, education, religious, literary, or scientific work. Because their work benefits the public, nonprofits can receive tax-exempt status, meaning they don't pay state or federal taxes income taxes on any profits it makes.
Nonprofits must file with the IRS to get tax exemption, and need to follow organizational rules very similar to a regular C corp. They also need to follow special rules about what they do with any profits they earn, including that they can't distribute profits to members or political campaigns. Nonprofits are often called 501(c)(3) corporations, a reference to the section of the IRS that is commonly used to grant tax-exempt status in the U.S.
A Cooperative Corporation (often called “Co-op”) is a business or organization owned and operated democratically by all the members specifically to benefit the members. Owners of a cooperative are classified as "Patrons" rather than shareholders, which differs from normal shareholder’s dividends from stocks because “patronage dividends” are usually allowed to be deducted from tax liability for the cooperative.
A common example is a Credit Union Bank, which distributes profits and earnings generated by the cooperative among the bank members and approves business decisions through member (account holder) voting. Typically, an elected board of directors and officers run the daily functions of the cooperative while regular members vote on the “direction” of the cooperative, but amount of shares they hold does not affect the weight of their vote.
Although a cooperative can be used as a business structure for nearly any industry, it is not as common because it is usually not designed to generate large profits; however, statistics indicate that the resiliency of these organizations exceeds almost every other business structure because they are often very stable and well run due to their transparency and accountability, even with minimal profit margins. Tax status as a Cooperative can be a trick matter.
Cooperatives are normally classified under Subchapter T of the Internal Revenue Code at the U.S. Federal Level, which may or may not be the same under a specific state’s laws. Patrons are also not required to have an actual ownership interest in the cooperative, but can still be paid patronage dividends if this is properly structured into the cooperative’s Articles of Incorporation. This is a significant advantage over a normal corporation’s tax benefits; however the cooperative must comply with many regulatory requirements regarding classifying and documenting the source of income, the payment of patronage dividends (including time limits for them to be paid), and other filing requirements.
The Limited Liability Company is popular for combining the ”best of both worlds”: Liability protection, flexible management, few regulatory requirements, and no double tax.
Often referred to as “the best of both worlds”, LLCs are often the default choice of structure for most businesses. An LLC is a form of business structure and that establishes it as a separate legal entity from its owners. The LLC structure generally combines the benefits of corporations and a partnerships.
An LLC is distinct from a corporation because it is unincorporated, and is not taxed as a separate legal entity, and the profits pass through to the owners who are then taxed for it as personal income. LLCs are also distinct from partnerships because they still enjoy personal liability protection that corporations have, but still avoid the double taxation that corporations receive. While the costs and complexities of establishing and operating an LLC are typically higher than a partnership, they are usually also less than a corporation. LLCs are often more flexible than a corporation and may be well-suited for companies with a single owner when personal liability protection against lawsuits and debts are needed.
As a full-service business law firm with U.S., German and other European counsel, we will evaluate your business needs based on its activities, size, and complexity to establish the right foundation for your U.S. market entry. Our services include:
- Picking the right location for your business based on the local laws and your goals
- Structuring your business under the most advantageous legal entity for success and personal protection
- Plan the best tax strategy to maximize your benefits under local and international law
- Obtain the necessary licenses and permits to carry out all your business activities
- Apply for the visas your business will need to operate in the U.S.
- Ensure you have the necessary protection for your business’s intellectual property and trade secrets
- Make sure you have the necessary internal documents to allow your business to operate and grow according to your goals
- Provide all the contracts and support services to allow your business to start working
If you have a sincere interest to expand your business and enter the U.S. market, whether to establish a business or invest in the U.S., our team is ready to support you. We can answer all questions about U.S. immigration, visa, employment, contract, tax and corporate law, regardless of the complexity.
We can provide you with a consultation and ongoing legal services in German and English. Get in touch! The easiest way to reach us is by e-mail (firstname.lastname@example.org) or by phone (+49 69 76 75 77 80). Tell us more about your U.S. business and we will offer a service package tailored to your particular needs.
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