Types of New Jersey Business Entities
A general partnership is the basic, simplest form of business entity under New Jersey business law. Two or more people own the business. The main drawback is that the owners, called partners, are responsible for all of the partnership’s debts, judgments and other obligations. However, the main advantage is that the partnership itself pays no income tax. Thus, there is more profit to be distributed directly to the partners – in exchange for greater potential liability, the partners make more after-tax profit.
A partnership is simple, and inexpensive to create. In fact, when two people run an unincorporated business, they are “de facto” partners whether they call themselves a partnership or not. However, it is important to have a well written partnership agreement which delineates the partners’ rights and obligations; this is invaluable in preventing disputes down the road.
A sole proprietorship is essentially the same as an unincorporated general partnership, except there is only one owner. It has the same liability and tax treatment as a general partnership.
Under New Jersey partnership law, limited partnerships have general partners, whose rights and liabilities mirror those in general partnerships – they receive single taxation treatment but can be personally liable for the partnership’s debts. Limited partnerships also have limited partners who, on the other hand, do not have personal liability although they still enjoy the benefits of single taxation. Essentially, general partners run the company, and limited partners are investors with limited input into the partnership’s management. The partners’ roles should be spelled out in the partnership agreement.
Limited Liability Partnership
Limited liability partnerships, or LLPs, are most often used for the businesses of licensed professionals, like doctors, engineers or lawyers. Partners in LLPs have personal liability for the partnership’s debts and single taxation like a general partnership. However, in a limited liability partnership, partners are not liable for the professional negligence (ie., malpractice) of their partners.
In general (although not universally, see S corporations below), corporations are the exact opposite of partnerships. Generally speaking, owners of a corporation (called shareholders, because they own shares of the corporation) are shielded from personal liability by the “corporate veil,” but are subject to the double tax structure of having the business’s income taxed at the business level, and then having the funds distributed to them taxed as personal income. In order to maintain the corporate veil, the corporate formalities must be observed, and the business must actually be a separate entity apart form its owners “ – it cannot be their “alter ego.” Thus, for example, there can be no comingling of business and personal funds.
C-Corporations follow the basic corporate outline described above – limited liability and double taxation. The shareholders elect a board of directors, which directs the higher level policies and decisions, while they appoint officers who carry out the day-to-day business operations. There can also be multiple classes of ownership, and an unlimited number of owners who may freely transfer their shares.
An S corporation is similar to a C corporation in that it enjoys the limited liability protection of the “corporate veil.” However, an S corporation avoids the double taxation scheme of a C corporation – income is not taxed at the business entity level. However, it is generally more appropriate for smaller businesses because it can only have up to 100 shareholders and one class of stock (ie., only one type of ownership).
Limited Liability Companies
A limited liability company, known as an “LLC,” is probably the best of both worlds – the owners enjoy single taxation and limited liability. Like a partnership, profit is only charged to the owners as income, not to the business, and the owners thus receive more profits; and like a corporation, owners are generally not liable for the company’s debts. Management structure is more flexible. While there may be unlimited number of owners, unless the LLC’s operating agreement permits, there must be universal agreement to admit new owners.
Agreements Between the Owners
We cannot stress how important this is. When business owners go into a venture with their fellow owners it is essentially a business marriage, and every marriage goes through its rough spots. Often, a well written agreement between the owners will save the owners from splitting up and prevent litigation – and fights between the owners and breaking up the business only cost money – they are in no one’s interests. Based on our decades of experience counseling business owners and representing them in litigation, drafting these agreements is more than filling out forms to us – it is using our experience to prevent problems from arising in the future before they arise, and having methods in place for dealing with them if they do arise.
For more, click on the links below.
- Shareholder agreements for corporations
- Operating agreements for limited liability companies
- Partnership agreements for partnerships
Call us at (973) 890-0004 or fill out the contact form to schedule a consultation with one of our New Jersey business attorneys. We can help.