Common Forms of Business Ownership that Reduce Personal Liability

As a business owner, the type of business structure you select will determine how much personal liability you will have for business debts and income taxes. Starting a business is a difficult decision filled with choices. It is a complicated process that involves everything from choosing a name to deciding whether to offer stocks. One of the initial decisions you have to make as a business owner is the legal framework of your business–sole proprietorship, a partnership, corporation or something in between.  Evaluating the potential liability associated with your business will impact your choice of business structure. Generally speaking, if your business involves a high risk of getting sued and other potential serious legal troubles, you are on more solid ground forming as a corporation or a limited liability company (LLC) to protect personal assets.

General and Limited Liability Partnerships

A general partnership is one where multiple owners (partners) join together to divide profits any way they choose, but they also share the liability for all business activities. General partnerships are easy and inexpensive to form because they rarely require any specific filings. Most importantly, general partnerships offer the least amount of personal liability protection. Owners/Partners are personally liable for business debts. The personal assets of any partner can be used to cover business liabilities regardless of who incurred the liabilities. There is no limit on liability.

There are also limited liability partnerships (LLP) which provide additional liability protection. This structure protects some partners from specific liabilities of the others. This is attractive to professional groups like doctors, accountants, and lawyers because the partners will not be responsible for the malpractice of another partner. However, any liability the business incurs as an entity will impact all the partners.

Limited Liability Company (LLC)

This type of company is more expensive and time consuming to create, but it also provides additional protection. Owners must register an LLC with the Secretary of State and pay the customary fees, in addition to meeting filing requirements with the IRS. An LLC is taxed the same way as a partnership or corporation. The structure of an LLC is beneficial because it allows profits and losses to be allocated to reflect different levels of ownership. Another advantage of forming an LLC is that owners have limited personal liability for the business’ debts, even if the LLC owner is also one of the managers.

Understanding the Corporation Business Structure

A corporation is the most complex business structure because it has multiples levels of management and ownership. Forming a corporation is an expensive and involved process, which requires completing tasks such as appointing directors, creating by-laws, issuing stock certificates, and obtaining licenses or permits. Laws regarding the formation of corporations vary by state so it is important to check if the state in which you would like to incorporate has additional filing requirements or administrative obligations that are unique to that state. The benefit for a business to operate as a corporation is that it provides the greatest amount of liability protection because Corporations are considered entirely separate from their owners. For legal and tax purposes, corporations are separate entities, which means that owners have little to no personal liability for the business’ debts.

Case Studies: Common Forms of Business Ownership That Reduce Personal Liability

Case Study 1: Smith & Johnson Plumbing Partnership

Smith and Johnson decided to start a plumbing business together. They formed a general partnership, dividing the profits equally between them. Unfortunately, the business faced financial troubles, and several creditors demanded payment.

As a result of the partnership’s unlimited liability, both Smith and Johnson were personally responsible for the business debts. They had to use their personal assets to cover the liabilities, putting their savings and homes at risk.

Case Study 2: Brown & Davis Law Firm LLP

Brown and Davis, two experienced lawyers, formed a limited liability partnership (LLP) to provide legal services. One day, Davis made a significant professional error that resulted in a malpractice lawsuit.

Thanks to the LLP structure, Brown was protected from the liability incurred by Davis’s mistake. However, the partnership as a whole was still liable for any other business debts or obligations.

Case Study 3: GreenTech Solutions LLC

GreenTech Solutions, a startup specializing in renewable energy solutions, was formed as a limited liability company (LLC). The company’s owners, Smith and Johnson, registered the LLC with the Secretary of State and enjoyed the benefits of limited personal liability.

When the company faced financial challenges, Smith and Johnson were only at risk of losing their investment in the business and were not personally liable for its debts. This protection shielded their personal assets from being used to cover business liabilities.

Case Study 4: Tech Innovators Inc.

Tech Innovators Inc., a technology company, decided to incorporate as a corporation to take advantage of the greater liability protection it offers. The founders, Smith and Johnson, went through a complex and expensive process to establish the corporation.

Once incorporated, the company became a separate legal entity, independent from its owners. As a result, Smith and Johnson had minimal personal liability for the business’s debts and obligations. Even if the company faced lawsuits or financial difficulties, their personal assets remained protected.