Illinois Business Entity Selection
An entrepreneur or potential new business owners of a wine business first must decide under which business entity will it operate. As discussed in other pages of our business law firm’s website, there are four major categories of Illinois business entities to choose from: 1) sole proprietorship; 2) partnership (general partnership, limited partnership, limited liability partnership); 3) limited liability company (LLC) and 4) corporation (S corporation and C corporation). In selecting the type of Illinois business entity, the entrepreneur or potential new business owner must consider a number of business law factors, including taxation, liability, raising capital and control.
A partnership, or general partnership, occurs when two or more people agree to conduct business together. Like a sole proprietorship, no specific partnership agreement is required, or formal business registration with the Secretary of State, before a partnership is formed. Two or more individuals simply need to agree that they wish to enter into business together (for a profit) and a partnership is formed. In the absence of a partnership agreement indicating otherwise, most states will require that each partner has equal rights to manage the partnership and share equally in the profits and losses of the business. From a liability standpoint, such a partnership arrangement, even without an partnership agreement in place is devastatingly problematic. If any problems occur where someone or another business believes that one of the partners or the partnership owes money, whether from a debt, a breach of contract, or some kind of injury, the person or business entity asserting the business litigation can not only make the claim against all partnership assets, but also against all the partners personal assets – trust, real estate, personal property, stocks, future income. Again, there is potential that a devastating situation could arise when choosing this business entity.
Limited Liability Company
The limited liability company structure provides numbers business law and tax advantages to the entrepreneurs or prospective business owners of a wine business, along with flexibility in the future growth, expansion of the wine business. From a liability standpoint, an LLC provides a great level of protection to all the members of the LLC as compared to the partnership business structure above. From a governance standpoint, every managing member (or if there is no managing members then all members) control the the majority of decisions regarding operation of the wine business. This is especially beneficial if the LLC anticipates raising capital, attracting investors, or becoming indebted to third party creditors.
An S Corp is incorporated and shares of stock are issued. However, there are a limited number of shareholders that can be involved (100), and an S Corp can only have one class of shares. S corp shareholders must be individuals, estates, and certain trusts, and qualified retirement plans. From a tax standpoint, the corporation files its taxes and the members take their dividend from the corporation and pay taxes on it like a partnership income, assuming the S Corp has elected to be taxes as a partnership. From a liability standpoint, an S Corp provides the maximum level of protection to all of the members of the Corporation.
From a governance standpoint, the management of the corporation is performed through a board of directors and its appointed officers who serve at the discretion of the board. The directors are voted into office by the shareholders. Unless the bylaws state otherwise, the corporate statutes require certain corporate formalities to be followed, such as annual meetings of the shareholder and of the board of directors. Each of these meetings need to be documented.
The corporate bylaws, shareholder agreement need to meet a variety of policies and procedures, including entity governance, succession of management, structuring most voting rights, structure of percentage distributions and decision making with respect to liquidation and dissolution. this is also a pass through entity which means it is subject to partnership taxation: the net income and losses of the entity are assed through to the owners of the company rather than being taxed at the entity level.
Unlike S Corp, C corps are not allowed pass through taxation, but it does allow for unlimited shareholders and multiple classes of voting and non-voting stock. Particularly for the wine business, an S Corp’s tax treatment of losses, profits, retained earnings and distributions of sale of the company (as a pass-through entity) is preferable than that of a C Corp. Where a startup wine business can foresee incurring initial losses, and the owners have other income that could be offset by such losses, a pass-through entity is advantageous. However, in certain circumstances the taxpayer’s ability to offset losses may be limited by the owner’s tax basis in the entity. Losses of a C Corporation do not pass-through, but are allowable as deductions only against future taxable income of the Corporation. A C Corporation is also subject to double taxation on sale of the corporate assets. The gain is taxed as ordinary income at the corporate level and net distribution is taxed at the shareholder level as income, generally capital gain. The double taxation aspect of the C Corporation entity choice is particularly dramatic where the C Corporation is the owner of appreciated real property or other appreciated assets such as goodwill.