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Business Entities in Colorado
Business entities in Colorado are generally by Colorado Revised Statutes (“C.R.S.”) § 7-1-101 to § 7-137-301 and Internal Revenue Service (“IRS”) tax regulations. Broadly speaking, there are 7 types of entities that are commonly formed in Colorado. Those entities are:
– Sole Proprietorships
– General Partnerships
– Limited Partnerships
– Limited Liability Companies
– C Corporations
– S Corporations
– Professional Corporations
Each of these types of business entities have their own distinct characteristics, including how they are formed, how they are taxed, and how liability flows from each entity to its owners. These entities will be discussed in sequence below.
Sole Proprietorships in Colorado
A sole proprietorship is generally regarded as the simplest type of business entity. It is an unincorporated business and is owned and operated by a single individual. Because it is unincorporated, there are no formal business filings that are required to incorporate or otherwise form the entity.
However, where the sole proprietorship is being operated under a name that is different from the owner a Statement of Trade Name must be filed with the Colorado Secretary of State. See C.R.S. § 7-71-101. The Statement of Trade Name informs the state and the public who owns and is affiliated with the business.
With respect to liability, for sole proprietorships there is no legal distinction between the business and its owner. Accordingly, the owner is personally liable for all business debts, obligations, and liabilities. If the business fails or if the business takes on more debts than it can handle, its creditors can go after the owner’s personal assets in order to satisfy the business’s unpaid debts. The lack of limitation on personal liability is one of the most significant drawbacks to forming a sole proprietorship since doing so places its owner’s personal assets at risk.
For taxation, sole proprietorships exhibit “flow through” tax status meaning that all income and losses from the business are reported as personal income or losses for the owner’s tax return. That is, the business entity does not file its own tax returns nor is the business entity itself taxed; instead, sole proprietorships are taxed only at the individual level.
Importantly, because sole proprietorships are taxed at the individual level, owners are considered self-employed and, accordingly, are responsible for self-employment taxes which traditional employees are not. More specifically, in traditional employee-employer relationship, the employer is responsible for paying half of the employee’s Social Security and Medicare taxes; however, since in a sole proprietorship the owner is her own employer, she is responsible for paying both halves.
Unfortunately, the additional tax rate can be a substantial amount as the employer’s share is approximately 15%. Accordingly, a sole proprietor can end up paying a 15% higher tax rate than traditional employees who are not self-employed.
General Partnerships in Colorado
Under Colorado law, a general partnership is formed by “the association of two or more persons to carry on, as co-owners, a business for profit . . . .” See C.R.S. § 7-64-202; C.R.S. § 7-60-106. Importantly, a partnership can be formed by oral or written agreement or inferred from the actions of the parties. Where profits from a business are shared, it will be presumed that the people receiving the shares are partners in the business. See C.R.S. § 7-64-202; C.R.S. § 7-60-107.
There are two sets of statutes that govern general partnerships in Colorado. The Uniform Partnership Law Act, C.R.S. § 7-60-101, et seq.; and the Colorado Uniform Partnership Act (1997), C.R.S. § 7-64-101, et seq. The Uniform Partnership Law Act is an older act that governs general partnerships formed before January 1, 1998. In contrast, the more recent Colorado Uniform Partnership Act (1997) governs partnerships formed on January 1, 1998 or later; as well as older partnerships that specifically elect to be covered by it. Accordingly, the Colorado Uniform Partnership Act (1997) is the act that governs most general partnerships formed in Colorado.
With respect to liability, in a general partnership each partner is jointly and severally liable for all debts and obligations of the partnership. See C.R.S. § 7-64-306; C.R.S. § 7-60-115. Accordingly, and similar to sole proprietorships, creditors of a general partnership can go after any general partner’s assets to satisfy the unpaid debts and obligations of the partnership. The exposure of a general partner’s personal assets to liability is something that should seriously be considered before deciding to form a general partnership as opposed to another business entity.
For taxation purposes, although a partnership is considered a separate legal entity, the profits and losses of a general partnership are still subject to “flow through” taxation meaning that business itself is not taxed but, instead, the partners are taxed at an individual level. That is, the profits and losses are passed along to each partner and reflected as such on each partner’s individual tax returns. Additionally, because general partners are self-employed, they are subject to self-employment taxes, as discussed above, which can result in a higher overall tax rate.
Importantly, where a general partnership is formed, the partners owe fiduciary duties to the business which include, among other things, accounting to the partnership for any benefit derived from the operation the business; refraining from using partnership assets for the benefit of a partner; and refraining from conducting a business that is in competition with the partnership. See C.R.S. § 7-60-121; Robert C. Montgomery, The Fiduciary Duties of General Partners, 17 Colo.Law. 1959 (1988).
Limited Partnerships in Colorado
Limited partnerships are, in essence, a type of partnership where one or more partners have less liability than they would otherwise have if they were general partners. Specifically, a limited partnership is formed in Colorado “by two or more persons having one or more general partners and one or more limited partners.” See C.R.S. § 7-62-101
Limited partnerships are governed by the Colorado Limited Partnership Act of 1981, C.R.S. § 7-62-101, et seq. See C.R.S. § 7-61-129.5. Notably, in forming a limited partnership under the act, while the partnership agreement is not required to be in writing, a certificate of limited partnership does need to be filed with the Colorado Secretary of State. C.R.S. § 7-62-201.
Where a limited partnership has properly been formed in compliance with Colorado law, the limited partner will not be personally liable for the debts and obligations of the partnership unless the limited partner participates in the control of the business. See C.R.S. § 7-62-303. However, general partners will still be personally liable for all of the debts and obligations of the partnership. See C.R.S. § 7-62-403.
Accordingly, the primary advantage of a limited partnership is that limited partners can invest or provide capital to a business while at the same time protecting their own personal assets from liability, a significant advantage over a general partnership.
With respect to taxation, limited partnerships are taxed as a “flow through” entity. That is, the partnership itself is not taxed but, instead, the profits and losses of the partnership are reflected on the individual tax returns of its partners.
Limited Liability Companies in Colorado
A limited liability company (“LLC”) is a highly popular type of entity that combines “flow-through” taxation with limited liability status for the company’s owners. LLCs in Colorado are governed by the Colorado Limited Liability Company Act, C.R.S. § 7-80-101, et seq.
Under C.R.S. § 7-80-203, a LLC may be formed by “one or more persons . . . by delivering articles of organization to the secretary of state for filing.” See C.R.S. § 7-80-203. Importantly, while a LLC is required to have at least one member, members of a LLC can appoint managers to run and make decisions on behalf of the company. Accordingly, a LLC can either be member-managed or manager-managed. See C.R.S. § 7-80-402.
Similar to other business entities, where a LLC is formed, the members and – if applicable, managers of the company – owe fiduciary duties to the company. Specifically, members and managers owe a duty to account to the LLC; to hold as trustee any property, profit, or benefit derived from the conduct of the company; to refrain from dealing with the LLC in an adverse manner; and to refrain from competing with the LLC. See C.R.S. § 7-80-404(1).
With respect to liability, where a LLC is properly formed, its formation protects its members and managers from personal liability. See C.R.S. § 7-80-705. Accordingly, a LLC owner’s personal assets are not at risk and cannot be seized to satisfy the debts and obligations of the company.
Importantly, however, where a member or manager is using the company as an alter ego – that is, not using the company as a legitimate business form – the liability protection offered by the LLC can be pierced. In such circumstances the members’ managers’ personal assets will be at risk and can be used to satisfy the debts and obligations of the company.
For taxation purposes, a LLC is a “flow through” entity such that the profits and losses of the LLC are passed on to its members and taxed at the individual level. The LLC itself does not pay taxes on its annual profits or losses. Accordingly, because the LLC is taxed as a flow through entity, its members will owe self-employment taxes as discussed above.
C Corporations in Colorado
C Corporations represent the traditional type of corporate form most people associate large business with. In Colorado, C Corporations are governed by the Colorado Business Corporation Act, C.R.S. § 7-90-101, et seq. Importantly, in order to properly form a C Corporation under the act, Articles of Incorporation must be filed with the Colorado Secretary of State.
In general, a C Corporation is a business entity that is owned by shareholders but is run and operated by its directors and officers. See C.R.S. § 7-108-101; C.R.S. § 7-108-302. Similar to LLCs and S Corporations, the shareholders of a C Corporation cannot be held personally liable for the corporation’s debts and liabilities. That is, the owners of a C Corporation are shielded from personal liability if the business were to fail.
However, unlike LLCs and S Corporations, C Corporations are subject to double taxation. That is, the profits of C Corporation are taxed at the corporate level and at the individual level when the corporation’s profits are distributed to its shareholders. Accordingly, while a C Corporation offers insulation from liability, its main tradeoff is that it results in higher overall taxation rates.
S Corporations in Colorado
An S Corporation is a type of corporation entity that exists under the Internal Revenue Code and, accordingly, is not created under Colorado law. While there are no specific Colorado filing requirements for electing into the S form of a corporation, the IRS does require particular forms to be filed. Importantly both LLCs and C Corporations can elect into the S corporate form.
Overall, forming an S Corporation is a mix between forming an LLC and a traditional C Corporation. Specifically, an S Corporation maintains all the non-tax protections that a C Corporation has under Colorado law; however, an S Corporation still maintains its “flow through” taxation status. That is, an S Corporation is essentially a C Corporation that is taxed like a LLC.
More specifically, with respect to liability, similar to C Corporations shareholders and managers of an S Corporations are not personally liable for the debts and obligations of the business. However, because an S Corporation has special status, there are more restrictions on who can be a shareholder as compared to shareholder restrictions for C Corporations.
For taxation purposes, S Corporations are similar to LLCs in that they exhibit “flow through” taxation. However, S Corporations differ in that, while owners of an LLC will be subject to paying self-employment taxes, shareholders of a S Corporation can elect to pay its owners a reasonable rate of compensation and then distribute its remaining profits as a dividend. The dividend distribution is not subject to the self-employment tax.
Accordingly, owners of an S Corporation will only have to pay self-employment taxes on the compensation they receive from the company and not the dividends received. An outcome which can result in substantial tax savings as compared to LLCs which have to pay self-employment taxes on all distributions to its owners.
Professional Corporations in Colorado
Under Colorado law, certain professionals are only permitted to operate a business in specific entity forms. Those entity forms are corporations, limited liability companies, or limited partnerships. Where those professional s choose to form a corporation as opposed to other forms, they form a special type called a professional corporation.
Professional corporations are governed generally by C.R.S. Title 12, Professions and Occupations. Importantly, the requirements for a professional corporation vary between professions. In general though, professional corporations differ from normal corporations because they have restrictions on who can own stock in the company and who can manage and make decisions on behalf of the company; have reporting requirements to appropriate licensing authorities; and have minimum insurance requirements that must be met in order for its owners to relieved from personal liability.
Examples of professionals that are permitted to form a professional corporation include:
– Physical therapists;
– Psychologists; and
– Professional counselors.
Where a professional corporation is formed, the corporation must also comply with the Colorado Business Corporation Act and can exercise any power, rights, and privilege conferred upon corporations by the act.
Accordingly, professional corporations are subject to the same insulation from liability as other corporations, provided the proper insurance requirements are met; and are subject to the same taxation schedule as well.
© 2017 J.D. Porter, LLC. Author: Jordan Porter. Denver, Colorado.