South Carolina Lawyer
SC Lawyer, March 2006, #2.
The ABCs of Entity Choice
South Carolina LawyerMarch 2006The ABCs of Entity ChoiceBy Thomas A. BrumgardtEvery lawyer needs to know the basics of advising clients on choice of entity. Even if you do not regularly practice in the corporate area, you are likely to be asked at least occasionally to help a family member or a client form a business. Although many assume that the limited liability company is the best choice for all clients, there are a number of important factors that should be considered, including personal liability protection, management rights, rights to distributions, transferability of interests, flexibility, annual maintenance obligations and tax issues. The purpose of this article is to highlight the basic characteristics of the various for-profit business vehicles available in South Carolina and help non-corporate lawyers better understand the issues that should be considered in the selection of an entity.
A sole proprietorship is an enterprise that is owned by a single person and is not incorporated or otherwise formally organized as an entity under state law. The proprietorship is not a legal entity separate from the owner, and there are no filings or filing fees (or attorneys' fees) required to form the proprietorship. The owner has full control over the management of the business and has the right to receive all of the cash flow from operations and all proceeds from liquidation. However, the owner also has unlimited personal liability for the debts and obligations of the business, including all tax liabilities. There are no annual filings or corporate formalities required to maintain a sole proprietorship except as may be required for business licenses and similar items.
Although this form of business is simple and inexpensive to start and maintain, the potential exposure to personal liability is significant, and it would be prudent generally to advise clients to choose a form of business which provides limitations on such liability.
A general partnership is an association of two or more co-owners who come together to operate a business for profit. S.C. Code Ann. § 33-41-210 (West Supp. 2004). There are no filings or filing fees required to form a general partnership, and a general partnership may be formed without the partners expressly organizing or even realizing that a partnership was created. The existence of a general partnership is a question of fact, and certain statutory rules apply to determine whether a partnership exists. See S.C. Code Ann. § 33-41-220 (Law Co-op. 1990). For example, the sharing among persons of the profits of a business is prima facie evidence that a general partnership exists. S.C. Code Ann. § 33-41-220(4) (Law Co-op. 1990). Thus, if a group of clients begins to conduct business before coming to your office for choice of entity advice, the clients may have already formed a general partnership. Any conversion from a general partnership to another type of entity may raise significant tax issues that should be considered before advising clients to move forward with such a conversion.
General partnerships are governed by the South Carolina Uniform Partnership Act (UPA), S.C. Code Ann. §§ 33-41-10 to -1330 (Law Co-op. 1990 & West Supp. 2004). Certain provisions of the UPA may be modified by an agreement among the partners. For example, the partnership agreement may vary the default rules of the UPA regarding management rights, transfer of interests and allocations of profits and losses and liquidation proceeds. S.C. Code Ann. § 33-41-510(1), (5) (Law Co-op. 1990 & West Supp. 2004). This gives general partnerships flexibility to customize the partnership agreement in order to fit the unique needs of its owners. However, unlike limited liability company operating agreements (as discussed below), partnership agreements may amend only those provisions of the UPA that expressly permit such modification. The discussion below is based on the UPA default rules and assumes the absence of a partnership agreement to the contrary.
All partners have equal rights in the management of the partnership and share equally in the profits and losses of the business. S.C. Code Ann. § 33-41-510(1), (5) (Law Co-op. 1990 & West Supp. 2004). Each partner is an agent of the partnership for purposes of conducting its business and generally can bind the partnership when apparently carrying on in the usual way the business of the partnership. S.C. Code Ann. § 33-41-310(1) (Law Co-op. 1990). Each partner is taxed at the individual level on the profits of the partnership, and there is no entity level tax imposed on the partnership itself (thus avoiding the "double taxation" of corporations as discussed below and potentially resulting in lower tax rates and other tax advantages for partners). As with sole proprietors, partners have no statutory limits on their personal liability - all partners are jointly and severally liable for the debts and obligations of the partnership. S.C. Code Ann. § 33-41-370(A) (West Supp. 2004). A partner may transfer its partnership interest, but such a transfer entitles the transferee only to receive the distributions to which the transferor would otherwise be entitled and not any management or other rights. S.C. Code Ann. §§ 33-41-740(1) (Law Co-op. 1990).
There are no annual filings or other maintenance obligations required of a general partnership except with respect to business licenses and similar items. However, the duration of a partnership is not perpetual. A partnership dissolves upon any change in partners or upon other events described in the UPA or the partnership agreement. See S.C. Code Ann. §§ 33-41-910 to 940 (Law Co-op. 1990). After dissolution, any assets remaining after the payment of other partnership liabilities are first applied to repay the capital contributions of the partners and then distributed equally to the partners. See S.C. Code Ann. §§ 33-41-510(1), -1060 (Law Co-op. 1990).
The general partnership provides advantages in terms of flexibility and (possibly) taxation. However, the potential liability exposure to partners is significant, and in light of other available options that combine the advantages of a partnership with limited liability, there are limited circumstances in which a general partnership would be advisable. Two of these other available options include the limited partnership and the limited liability partnership as discussed below.
A limited partnership is a form...