As an independent producer, you’re (hopefully) concerned about protecting your rights and limiting your liability. You’ve heard a lot about different types of legal entities, but which one is best for you? This post will cover some of the basics of six distinct legal entities.
Entertainment attorney Schuyler Moore has said that “[i]f someone in the film industry asks, “What entity should I use . . . ,” you can shout, “LLC!” and be right 99% of the time without even hearing the rest of the question.” The Biz: The Basic Business, Legal and Financial Aspects of the Film Industry, 4th Edition, p. 41. That reality notwithstanding, there are five other legal entities that the independent producer should have some degree of familiarity with. Remember that before choosing any particular legal entity, you should seek the advice of an entertainment attorney and tax professional.
The six legal entities
1. Sole proprietorship
A sole proprietorship is technically not a separate legal entity. A sole proprietorship is nothing more than a natural person (meaning a human, rather than a legal person, such as a corporation) doing business under a fictitious business name (d/b/a). This is the main disadvantage to a sole proprietorship – a sole proprietorship does not provide any limited liability, meaning that the natural person running the sole proprietorship is personally responsible for the debts and obligations of the business. Additionally, because the sole proprietorship is not a separate, distinct legal entity, it dies along with the sole owner (by contrast, a corporation may continue in perpetuity). An advantage to using a sole proprietorship is that the individual and the company are treated as one (in fact, legally speaking, they are one) and taxed accordingly. This stands in contrast to the double taxation of a corporation, discussed below. This type of taxation translates to some degree of administrative simplicity.
2. General partnership
A general partnership is formed when two or more natural persons join together to carry on a business and share profits and losses. No state administrative filing is required to form a general partnership, although a partnership agreement will govern various aspects of the general partnership, such as whether the general partnership will dissolve upon the death, bankruptcy, resignation, expulsion, or dissolution of one or either of the partners. A general partnership is advantageous because it is not subject to double taxation and the income and losses of the partnership are passed through to the partners. The partners can then deduct the losses to the extent permitted by applicable tax law. One disadvantage of a general partnership is that it offers no limited liability. The partners remain personally liable for the partnership’s debts.
3. Limited partnership
A limited partnership is not formed until a filing is made with the Secretary of State in the state where the partnership is formed. A limited partnership differs from a general partnership in the sense that there are two classes of partners: general and limited. The general partners in a limited partnership control the daily affairs of the partnership and remain personally liable for the partnership’s debts. The limited partners are not able to control the daily affairs of the partnership, but can vote on specified important issues (pursuant to the partnership agreement), and are not personally liable for the partnership’s debts. The limited liability of the limited partners and the transparent tax treatment are the two main advantages of a limited partnership. The main disadvantage of a limited partnership is the personal liability of the general partners.
4. C corporation
A C corporation is formed when articles of incorporation are filed with the Secretary of State. Ownership of a C corporation is different from ownership of both types of partnerships, in that ownership of a C corporation is evidenced by shares in the corporation. All shareholders enjoy limited liability as they are not personally liable for the corporation’s debts. The principal advantage of forming a C corporation is that the C corporation is the only type of legal entity that can go public. Going public is a lengthy and expensive process but may potentially lead to significant capital formation both short-term (through the initial public offering) as well as long-term (through subsequent securities offerings). The most significant disadvantage to a C corporation is the imposition of double taxation. Double taxation means that the corporation’s income is taxed at the corporate level, then the shareholders are personally taxed when the corporation’s income is distributed to them. Additionally, corporate losses remain on the corporation’s books and cannot be deducted over time by the shareholders (whereas the partners in a general partnership, for example, would be able to deduct losses over time to the extent permitted by applicable tax law).
5. S corporation
An S corporation is identical to a C corporation for most purposes. The main differences are: (i) shareholders must affirmatively elect S corporation status, which will allow the corporation to be treated as transparent for tax purposes (meaning no double taxation); and (ii) the profits and losses of the S corporation are passed through to the shareholders. There are significant trade-offs to this preferential treatment, however, in the form of ownership restrictions imposed on S corporations (that C corporations, by contrast, are not subject to). S corporation ownership is limited to 100 natural persons (meaning that only humans can own shares of the company) and S corporations may only have one class of stock (whereas, by contrast, C corporations can issue different classes of stock, such as common and preferred). Additionally, the 100 natural persons must be United States citizens. The S corporation is advantageous because of the ability to elect preferential tax treatment and for its limited liability, but disadvantageous because of its ownership restrictions and administrative complexity.
6. Limited liability company
The LLC is almost always the ideal legal entity to use in the entertainment industry. LLCs are not subject to double taxation and offer limited liability. LLCs are similar to corporations in that articles of organization (the LLCs version of the corporation’s articles of incorporation) must be filed with the Secretary of State, the company is governed by an operating agreement (the LLCs version of the corporation’s bylaws), and ownership is evidenced by membership interests (you can think of these as similar to shares of a corporation). There are two principal disadvantages to the LLC: (i) it cannot go public; and (ii) the majority of angel investors, venture capitalists, and private equity firms will not fund LLCs, preferring instead to deal with C corporations (the reasons for this are many, but it’s mainly because the body of corporate case law is so much older and more developed, translating to more confident risk assessment).
by: Latha R. Duncan