Types of Entities Available Under New Jersey Business Law
New Jersey business law offers different options for the forms which business entities can take. Each has its advantages and disadvantages. Traditionally, the choices were corporations, partnerships and sole proprietorships.
Corporations are usually chosen, particularly in the context of small businesses, for the protection they provide. The corporate form erects a shield, known as the “corporate veil,” which protects owners from the debts and liabilities of their business. So, for example, if the corporation owes a supplier and doesn’t pay, the supplier can recover from the company but not the owners. Likewise, if someone is injured by the company’s negligence they can only sue the business, not the owners.
Of course, there are disadvantages to the corporate form as well. For instance, when a small corporation borrows large sums from a bank, the bank will normally require the owners to personally guarantee the debt, which defeats the purpose of the corporate shield. Likewise, corporations are normally subject to “double taxation.” The corporation’s profits get taxed at the business level as income to the corporation. Then when the profits are distributed, they get taxed again to the owner as personal income.
Partnerships and sole proprietorships, on the other hand, only have “single taxation.” That is why they are known as “flow through” entities. The profits flow through the business to the owners without being taxed at the business level. They are only taxed at the individual level. This can cause significant savings. For example, if a corporation earns $100,000 in profits and is taxed at an effective rate of 25 percent, $75,000 flows to the owner. If the owner is also taxed at an effective rate of 25 percent, the tax on the $75,000 in profit he received is $18,750, leaving him a net profit of $56,250. On the other hand, in a partnership or sole proprietorship the whole $100,000 “flows through” to the owner without tax at the business level. If the owner then gets taxed at an effective rate of 25 percent, he gets to keep $75,000 instead of $56,250.
The drawback is that in a partnership and sole proprietorship the owner is personally responsible for the debts and liabilities of the business. So in the examples above, the supplier and the injured person can sue and recover from the owners personally.
Limited Liability Companies, A Great Solution
In 1994 New Jersey adopted the Limited Liability Company Act as a way to create business entities with the advantages of corporations, partnerships and sole proprietorships without the corresponding disadvantages. In 2012 the Legislature adopted the New Jersey Revised Uniform Limited Liability Company Act, to make LLC’s even more efficient.
The beauty of the limited liability company is that it combines the limited liability protection of a corporation’s “corporate veil” with the “flow through” single taxation structure of partnerships and sole proprietorships. Therefore, with few exceptions, the LLC is the preferred form of entity for businesses under New Jersey business law.
Our transactional attorneys assist clients in forming LLC’s and drafting their operating agreements. Our business attorneys also represent people and businesses in the purchase and sale of LLCs. Our business litigators represent LLCs and their owners in business litigation and disputes between the owners. We represent them in litigation, arbitration and mediation. Call us at (973) 890-0004 or fill out the contact form. We can help.