Branch, Partnership, LLC or Corporation? Liability & Management
Before explaining in details the difference with these entities, some investors choose to set up an office or a branch (in French “succursalle”) rather than a subsidiary. The main difference between the two is that the subsidiary is a separate legal entity, whereas a branch belongs to the same entity as the parent company and does not have a legal distinct entity, it is part of the parent company. It is dangerous to create a branch for liability reason, because the parent company is directly liable for the act of its branch.
The parent company has the duty to the subsidiary to promote the corporate interests of that subsidiary; to act in his best interest, and maintain a distinct identity. If the parent does not meet these requirements, the courts will consider the two entities as one and a court may “pierce the corporate veil” of the parent if it finds an appearance of impropriety through questionable share transfers or other fraudulent means of avoiding the subsidiary’s liabilities.
Courts might also subordinate the parent’s debts to outside creditors if the parent has engaged in unfair conduct, such as influencing new creditors to extend credit to the subsidiary while knowing the subsidiary’s poor financial condition.
A- The partnership: the risk of unlimited liability
A partnership is a combination of two or more people acting as co-owners of a for-profit business. The properties of the partnership are held by the partnership itself as entity and not by the partners as co-owners.
Each partner is jointly and severally liable for all obligations resulting from the activity of the entity. This means that each partner may be held liable for obligations and debts of the Partnership beyond its own investment in the partnership. Therefore this schema is not recommended. There are two types of partnerships:
- General partnership: is a partnership in which all the partners are jointly and separately liable for the debts of the partnership. In most U.S. states, it can be created by agreement without requiring a public filing. The partners may themselves be legal entities or individuals.
- Limited partnership: a partnership where at least one partner (the general partner, which may itself be an entity or an individual) has unlimited liability for the LP’s debts) and one or more partners (the limited partners) have limited liability (which means that they are not responsible for the LP’s debts beyond the amount they agreed to invest). Limited partners generally do not participate in the management of the entity or its business.
B- The LLC: Equivalent of the SARL in France
Flexibility of Management
The LLC is a hybrid structure between the partnership and the corporation. Members have a limited liability and the management and maintenance of the LLC is extremely simple is not subject to any formalities.
The owners in an LLC are called members. They have units of ownership called membership interests that show what percentage of the company they own and how much influence they have.
Unlike Corporations, LLCs offer a lot of flexibility in how you issue membership. For instance, your LLC can have many different forms of membership, called classes. If your LLC has only one member, it’s called a single-member LLC. Unless the single member LLC elects corporate taxation, the IRS treats it as a sole proprietorship for tax purposes.
Two types of LLCs exist:
- A member-managed LLC is managed jointly by all of its member
- A manager-managed LLC is managed by one or more – but not all – of the members or by separate (non -owner) managers altogether.
If you are forming an LLC with only a few owners (members), and each owner is going to have a say in managing the company, then you may want to choose member-management. However, if you decide to take on a silent partner and that person is not managing the business day-to-day, then your LLC need to be manager-managed. All members, except for the silent partner are listed as manager.
Unless all the members are managing he company’s day-to-day business, your LLC is considered manager-managed.
C- The Corporation: equivalent of a “Societe Anonyme” in France
Like in France, a corporation is usually governed by the Board of Directors (except for small corporation which can be directly governed by its shareholders and managers upon written agreement of shareholders). The shareholders in a Florida corporation elect directors. Officers are than appointed by the Board of Directors and remain in that capacity until their removal by the same board.
The Corporation is nevertheless (much more than in France) for larger companies because, unlike LLC, Corporations have automatic free transferability of ownership interests (called stock). However, its creation is simpler because unlike France no minimum capital is required and it can have only one shareholder.
When a corporation issues dividends to its shareholders, it doesn’t have the same flexibility that an LLC enjoys. Dividends in a corporation must be issued in proportion to the shareholders’ ownership interests.
There are two types of corporations: Corporation C and Corporation S: Both have shareholders, directors and officers. Shareholders are the owners of the company and elect the board of directors, who in turn oversee and direct corporation affairs and decision-making but are not responsible for day-to-day operations. The directors elect the officers to manage daily business affairs. Both are required to follow the same internal and external corporate formalities and obligations, such as adopting bylaws, issuing stock, holding shareholder and director meetings, filing annual reports, and paying annual fees.
C corporations have no restrictions on ownership, but S corporations do. S corps are restricted to no more than 100 shareholders, and shareholders must be US citizens/residents. S corporations cannot be owned by C corporations, other S corporations, LLCs, partnerships or many trusts. Also, S corporations can have only one class of stock (disregarding voting rights), while C corporations can have multiple classes.
Branch, Partnership, LLC or Corporation? Taxes issues
- Florida Sales Tax: Florida sales tax rate is 6%.
- Florida State Tax: Florida does not have a state income tax.
- Florida Corporate Income Tax: Corporations that do business and earn income in Florida must file a corporate income tax return (unless they are exempt).
- Florida Property Tax: Florida Property Tax is based on market value as of January 1st that year.
Disregarded entity taxation: when considered a disregarded entity by the ITS, your company is treated as if it doesn’t exist, and you’re taxed simply as an individual.
Partnership taxation: it is a form of pass-though taxation (where the profits of the business pass through to the owner to be reported on their individual income tax returns).
LLC: If an LLC has at least two partners and the LLC doesn’t make any tax classification election with the IRS, then the LLC is automatically assigned the default, which is partnership taxation.
The business itself doesn’t pay federal income taxes; instead the profits of the business pass through to the owners to be reported on their individual income tax returns. The individual owners then pay regular personal income tax.
If you are a single-member LLC, you are not allowed to elect partnership taxation. Your default status is disregarded entity unless you elect corporation or S corporation taxation; the sole member pays personal income taxes and self-employment taxes on the company’s profits and/or losses on his personal tax return.
The difference in terms of taxes between an LLC and a Corporation is interesting: while the corporation is subject to double taxation, the LLC (with two or more members) will allow its members to avoid the double taxation. There will not be taxation at the Florida level for the LLC and the members will be taxed personally based on their profits in Florida. This aspect is very similar to the partnership except that the member of a sole member LLC will be consider as single entity in terms of taxation. However the LLC is taxed at the federal level.
Another important factor is that LLC members who actively work in the business are able to deduct the business’s operating losses on their personal tax return to offset other income. C corporation shareholders are not able to deduct these losses but S corporation shareholders can.
1- Corporation C:
The company’s profits (or loss) does not flow through to the owner of the business, but instead remains in the corporation and is subject to corporate income tax. You can distribute the profits to the shareholders in the forms of dividends. After, the profit is distributed to them; it’s taxed again at the shareholders level. Because the same profits are taxed twice – both at the corporate level and the individual shareholder level – this is commonly referred to as double taxation. The Florida Corporate Income Tax rate is 5.5%.
While C corporations are subject to double taxation, they offer more flexibility in terms of income shifting compared with pass-through entities like LLCs and S corporations. When an LLC is taxed as a pass-through entity, its members must pay taxes on their share of the profits, whether or not that money stays in the business or is distributed to their personal account.
By contrast, C corporation owners are taxed only on the actual amount they receive as dividends.
2- Corporation S: S corporation tax status is a pass-through tax status. The revenues and expenses of the business “pass through” to the shareholders’ individual tax returns. There is no double taxation.
Whether you are single-member LLC or you have multiple members, you can always elect to be taxed like a Corporation. The IRS considers a corporation to be entity completely separate from its owners; the corporation files its own tax returns. All a member must report on his personal tax return is the actual cash the company decides to distribute to him, whether in the form of dividends or salary.
Individual are required to pay federal income tax on all income. Corporations, on the other hand, only pay federal tax on the profits that the company generated throughout the year.
Additional Taxes: Social Security and Medicare Taxes and Foreign Company
For LLC and Corporation C must pay additional taxes for employment. Self-employment (SE) taxes are Social Security and Medicare taxes, and they are imposed in addition to the federal income taxes that you have to pay. These taxes amount to about 15,3% of the total income allocated to you. About 12,4% goes to the Social Security, which will be paid out to you when you reach retirement, and 2,9% goes to Medicare, which is a form of hospital insurance.
LLC members are not considered employees, so their share of the profit is not subject to social security or Medicare tax. However, LLC members who actively work in the business need to pay self-employment taxes on their income (including salary and their share of any profits). However, with a corporation, only the salaries are subject to social security and Medicare taxes. Any profit distribution isn’t subject to these taxes.
In terms of perks and benefits, there are some key differences between an LLC and a corporation. First, certain retirement plans, stock option and employee stock purchase plans are only available for C corporations. In addition, LLC members (as well as S corporation shareholders who own more than 2 percent of the business) need to pay taxes on certain employee benefits like health benefits, employer contributions to HSAs or FSAs, and life insurance benefits. Shareholders of a C corporation do not have to pay taxes on these benefits.
Unlike the LLC and Corporation C, in a Corporation S the amount of medical care and social security is limited to the amount you take as a salary.
There may be additional fees if must register your company in different states. By law, if you are doing business in states other than the one in which your LLC was formed, you must register in those states. This is called foreign-filling. If you think you might be required to foreign-file in a particular state, here are a few questions to guide you:
- Does your LLC operate out of a physical office or retail store in the state?
- Are you often physically in the state, meeting with customers and vendors, transacting business?
- Does a large portion of your LLC’s revenue come from that state?
- Do any of your employees physically work in the state?
If you are foreign-filed in multiple states, you need to apply for state and local business licenses. For paying taxes, in generally each state requires you to allocate a percentage of your sales according to an apportionment formula.
Most states use a common formula involving three factors of your business:
- The property factor is the average value of your in-state property divided by your total property
- The payroll factor divides your in-state payroll by total payroll
- The sales factor equals your in-state sales divided by total sales.
If you are selling tangible goods and will be paying sales tax in another state, you definitely need to open a separate bank account for that state. Keep your sales receipts for each state separate so you know which states to pay sales tax to.
Advantages/drawbacks of LLC/Corporation
|Advantages of an LLC||Advantages of a Corporation|
|· No limit on the number of owners
· Profit and loss are passed through to the owners’ individual tax returns and the business itself is no responsible for taxes on its profits: no double taxation. Taxes are not paid at the business level. If any taxes were due, they would be paid on the individual level
· No annual meeting or minute book requirements
· Flexibility in the management
· LLC can choose how it wants to be taxed and choose how to distribute the profits, who manages the business’s day-to-day affairs.
· Shareholders are not personally liable for actions taken by the corporation. The corporation C is an independent legal entity with separate legal taxes.
· When necessary it is easier to get financing from banks. Banks will be able appreciate the potentiality and the financial situation of the corporation through the mandatory accounting statements. This is not the case of a LLC or a partnership where accounts are less transparent.
· Self-employment taxes. An S corp. can provide savings on self-employment or Social Security/Medicare taxes, and it allows owners to offset non-business income with losses from the business — unlike a C corp. which is a completely separate tax entity
|Drawback of an LLC||Drawback of a Corporation|
||· Double taxation of corporate profits and shareholder dividends *
· Must hold annual meetings and record minutes
· S corporation have restrictions on number of owner.
Tax agreement between France and US
There is an agreement between both countries: US-France income tax treaty (August 31, 1994) which a lighter taxation of financial flows. The income tax issue: the possibility of complete exemption intra-group dividends
According to the French American Agreement, Dividends incomes are taxed at a fixed rate of 15%. The Company’s shares must have been held for 60 days for 120 days preceding the distribution. Regarding non-US holders, a distinction is made between investors: sleepy investors (financial rights) and direct investors (financial and voting rights).
Financial investors are those with less than 10% of the capital of the paying company. The
Direct investors are those who own 10% of the voting rights attached to shares of a company whose earnings are themselves not made for more than 20% of passive income.
The dividends paid to an investor that does not have 10% of capital are subject to a deduction at the source at 15%. When the ownership interest by the beneficiary of the dividend is higher, the withholding tax is reduced to 5% (for limited companies only).
However, if those dividends are linked to a permanent establishment in the United States and owned by the recipient, they are taxable locally with the financial numbers of this institution.
These withholding taxes are refundable under certain conditions in the country of residence
Note that dividends since the late ratification in December 2009 of the Agreement
Franco-American tax (D) are taxable at the standard rate of tax in France but
principle exempt from holding at 15% in the United States.
Branch, Partnership, LLC or Corporation? Liability issues
We already explained earlier that a branch does not shield the parent company from its own wrongful actions. Regarding partnership the partners are not protected either and face unlimited liability: The issue is really whether considering an LLC or a Corporation?
In both case the members/shareholders have their liability limited to the amount invested in the company.
Seizure of assets
If the business is set up as a corporation, the shareholder’s personal creditors cannot directly take over ownership of the corporation’s assets, such as its bank accounts, to pay off a judgment against him. However, they can obtain ownership of the shareholder’s stock in the corporation. They’ll be entitled to the shareholder’s share of the corporation’s profits and to participate in the corporation’s management. If they obtain ownership of 51% of more of the corporate stock, they can have the corporation liquidated and its assets sold to pay off the shareholder’s debt.
If the business is an LLC instead of a Corporation, things will work out differently for his creditors.
Just as with corporations, an LLC’s money or property cannot be taken by personal creditors of the LLC’s owners to satisfy personal debts against the owner. However, unlike with corporations, the personal creditors of LLC owners cannot obtain full ownership of an owner-debtor’s membership interest. Instead, LLC owners are not at risk of having another LLC member’s creditor step into the shoes of an LLC debtor/member and share in the management and control of the LLC.
All states permit personal creditors of an LLC owner to obtain a charging order against the debtor-owner’s membership interest. A charging order is an order issued by a court directing an LLC’s manager to pay to the debtor-owner’s personal creditor any distributions of income or profits that would otherwise be distributed to the debtor-member.
However, in most states, creditors with a charging order only obtain the owner-debtor’s “financial rights” and cannot participate in management of the LLC. Thus, the creditor cannot order the LLC to make a distribution subject to its charging order. Very frequently, creditors who obtain charging orders end up with nothing because they can’t order the LLC to make any distributions. As a result they are not a very effective collection tool for creditors.
A simple way to avoid the potential creditor problem is to make sure that your LLC has at least two members. The second member could be your spouse or another relative. Personal creditors are not permitted to take over the debtor-member’s LLC interest and join in the management of the LLC or have the LLC dissolved and its assets sold without the other members’ consent. However, this rationale disappears when the LLC has only a single member (owner) because there are no other LLC owner/members to protect.
A comprehensive operating agreement is particularly important for multi-member LLCs, since disputes may develop among the members.