Delaware Corporate Entities

Choosing your US business entity

We are pleased to offer this essential guide outlining the different methods by which a business may be structured in accordance with Delaware law.

Please note that the information provided here serves as a public resource and offers general descriptions that may not necessarily be applicable in all situations. It should not be considered as a source of legal or tax advice.

Introduction

In an increasingly complex society, businesses face expanding demands. The increase of state and federal laws and regulations that impact businesses has led to a growing risk of liability and losses that are unrelated to a business’s economic performance. Consequently, the legal structure in which a business operates has become more critical than ever.

The selection of an entity structure has also become more relevant. Key choices now encompass various options, including:

Whether you’re launching a new business, expanding an existing one, or considering a strategic alliance or joint venture, the choice of the appropriate business entity can significantly contribute to achieving your enterprise’s objectives. It can also help in minimizing conflicts among stakeholders and reducing or even eliminating personal liability risks.

Making an informed decision regarding your business entity is an integral part of sound business planning. To support such strategic planning, the subsequent sections provide concise descriptions of the main types of business entities. These descriptions are intended to offer information that can assist you in collaboration with your business advisors to determine the entity type that best aligns with your specific requirements. It’s important to note that these descriptions do not replace the need for consultation with your professional advisors.

Types of Delaware business entities

Sole Proprietorship

The most straightforward business structure is a sole proprietorship. In this setup, an individual commences business operations once they have obtained the necessary licenses, permits, and required documents. If the business operates under a trade name, a “fictitious name filing” must be completed to inform the public about the use of the trade name by the sole proprietor. This type of business is remarkably easy to initiate, manage, and dissolve since there are no formalities associated with its formation. It’s essential to note that a sole proprietorship does not establish a separate legal entity from the owner. Consequently, the sole proprietor bears personal liability for all the business’s debts and obligations, and there is no continuity of the business in the event of the proprietor’s disability or death. The sole means of transferring ownership of the business is through the sale of its assets.

Corporation

A corporation is perhaps the most commonly employed and understood form of business entity, established under state or federal law. It stands as a distinct entity separate from its owners, with the capacity to acquire, hold, and dispose of property, conduct business operations, and initiate or defend legal actions in its own name. The relationships, responsibilities, and rights of the corporation, its owners, and its management are primarily defined by legal statutes and the corporation’s certificate of incorporation and bylaws.

Delaware corporations

• Do not impose a minimum capital requirement.
• Do not necessitate a primary place of business in Delaware.
• Permit a single individual to serve as the sole director, officer, and stockholder.
• Have no residency prerequisites for directors, officers, or stockholders.

A unique category of corporation, known as the “professional corporation,” exists to accommodate licensed professionals such as doctors, architects, accountants, and attorneys who are legally or ethically bound to operate in a specific form that differs from a standard corporation. The key features of a professional corporation include allowing only licensed professionals as stockholders, each stockholder actively participating as a director in the business’s management, and each stockholder retaining personal liability for their professional negligence or malpractice and that of other individuals under their direct supervision and control.

General Partnership

A general partnership is essentially an arrangement between two or more individuals to jointly operate a business. The establishment of a general partnership does not involve formal requirements. Thus, a general partnership may come into existence through the actions and conduct of the parties involved or through an oral agreement. However, it is advisable to create a written agreement that outlines the respective rights and responsibilities of the partners. In the absence of such an agreement, the Revised Uniform Partnership Act provides some guidelines for establishing, operating, dissolving, and terminating a general partnership, but it is not a comprehensive substitute for a formal agreement.

Key characteristics of a general partnership include each partner serving as an agent for the partnership, possessing the authority to legally bind the partnership, and incurring personal liability for the partnership’s debts and obligations. Most business decisions can be made by a majority of the partners, although specific matters, such as admitting a new partner, may necessitate unanimous agreement.

For non-tax purposes, a Delaware general partnership is recognized as a distinct entity apart from its partners, permitting it to engage in business activities, acquire, hold, and transfer property, and initiate legal actions without the requirement of joining all partners as parties.

Limited Liability Partnership

Delaware provides legal authorization for a distinct type of general partnership known as a limited liability partnership. In this structure, the partnership is obligated to get filed with the Delaware Secretary of State and maintain a specified amount of liability insurance. In return, the partners are absolved of personal liability for the partnership’s obligations. However, partners remain personally liable for their negligence or misconduct, as well as that of individuals under their direct supervision and control. The limited liability partnership is particularly attractive to professionals seeking the benefits of a partnership while mitigating personal liability risks associated with the professional misconduct of other partners and employees.

Limited Partnership

Historically, the trade-off for limited liability was that limited partners were barred from participating in the partnership’s management, which was the sole domain of the general partner. Nonetheless, Delaware’s current laws concerning limited partnerships provide significant flexibility in this regard, enabling the construction of a limited partnership agreement that permits substantial involvement of limited partners in management without compromising their limited liability.

Without losing their limited liability status, limited partners can:

Limited partnerships can transition into limited liability limited partnerships, affording the general partner the same protection from personal liability as that enjoyed by general partners in limited liability partnerships.

Limited Liability Company

A limited liability company (LLC) is among the more contemporary and versatile business structures accessible in Delaware. Established by filing a certificate of formation with the Delaware Secretary of State, an LLC stands as a distinct legal entity with the authority to engage in business activities, hold and manage property, and initiate or defend legal actions in its own name. An LLC can comprise as few as one member, and management may be conducted by the members or designated managers, who may or may not be members themselves. Similar to limited partnerships, the relations among members and the management framework are typically outlined in a written LLC agreement. This agreement can delineate various member and manager classes, along with their corresponding rights, powers, and responsibilities. Additionally, it can specify the method of allocating profits and losses among the LLC’s members.

Key characteristics of an LLC encompass: (i) authorization for any member or manager to bind the LLC, (ii) protection from personal liability for the LLC’s debts or obligations, with only a few specific exceptions, and (iii) perpetual existence. These aspects can be altered through specific provisions within the LLC agreement.

Managing and Controlling your Business Company

One of the central considerations in selecting the most suitable business entity revolves around the issues of management and control, personal liability, tax implications, and regulatory compliance. It is the intricate interplay of these factors that ultimately guides the choice of a business structure for a specific endeavor.

Management and Control

Personal Liability

The extent of personal liability borne by business owners hinges on their choice of business structure. Entities such as corporations, limited partnerships, limited liability companies, and business trusts generally confer limited liability upon their owners. In these cases, unless specifically committed through a separate agreement like a personal guarantee, shareholders, limited partners, members, or beneficial owners are not personally responsible for the entity’s debts and obligations.

However, sole proprietors and general partners, whether in a general or limited partnership, carry unlimited personal liability when it comes to third-party obligations. A general partner may mitigate their liability by converting the partnership into a limited liability partnership (or a limited liability limited partnership for limited partnerships). In such cases, the general partner remains personally liable only for debts arising from their own negligence, misconduct, or wrongful acts, as well as those of individuals under their direct supervision.

Tax Implications

Tax considerations are invariably a critical factor in determining the most suitable business entity. Corporations are taxed as separate entities, liable for their corporate taxes, including income tax. Profits distributed to shareholders in the form of dividends are subject to a second layer of taxation as individual income.

Small businesses often qualify for Subchapter S status, affording a special tax status. Under Subchapter S, the corporation generally does not incur income tax at the corporate level. Instead, all corporate income is attributed to and taxed at the individual level for shareholders, whether or not the income is distributed to them.

Conversely, a sole proprietorship, being an extension of the owner, is not subject to separate taxation. All profits and losses are attributed to the owner and must be considered within the owner’s overall tax situation.

General partnerships, limited liability partnerships, and limited partnerships fall under the category of pass-through entities for tax purposes. Rather than facing entity-level taxation, profits and losses are passed through to the partners and allocated based on their ownership interests. Consequently, partnership income becomes part of a partner’s income, taxed at the partner’s individual rate. In limited partnerships, the ability of a limited partner to deduct losses is generally subject to specific limitations.

The tax classification of a limited liability company can vary, depending on its structure. Similarly, a business trust may be structured to fall under the tax categories of a corporation, partnership, or trust.

For foreign citizens, especially those not residing in the United States, the tax consequences of owning an entity like a limited liability company are a significant concern. A Delaware LLC that (1) does not engage in business activities in the U.S., (2) does not derive income from U.S. sources, and (3) has not opted to be treated as a corporation for tax purposes does not need to file U.S. or Delaware tax returns.

In accordance with current IRS “check-the-box” rules, a Delaware LLC that does not actively elect to be treated as a corporation will be recognized as a partnership for federal tax purposes. This designation holds true for Delaware tax purposes as well.

Furthermore, under existing Treasury Regulations, a partnership engaged in business outside the U.S. and deriving no income from within the U.S. is not required to file a tax return. Delaware law similarly dictates that a partnership only needs to file a return if it generates income from within the state.

Should a US LLC consist of only one member, it is disregarded for federal tax purposes, and the sole member is taxed as a sole proprietor. Treasury Regulations dictate that nonresident aliens not conducting business in the U.S. and not deriving income from U.S. sources are exempt from filing tax returns. Delaware law concurs, stipulating that nonresident aliens with no income from within the state are not obligated to file a Delaware return.