There are a number of different factors one must consider in forming an entity in New Jersey, chief among them: (a) how the entity will be taxed, (b) management, and (c) to what extent does the entity offer protection from personal liability. What follows is a brief description of entity formation in New Jersey, focusing on the above considerations.
“C” and “S” Corporations
Perhaps the most well known form of business entity is the “C” corporation. Companies such as Pepsi and Ford are “C” corporations. A “C” corporation is an entity that is separate and apart from its owners. What this means is that the earnings that are distributed to the owners are taxed both at the corporate level and at the personal level. The “S” corporation is a corporation with more favorable tax treatment. The profits and losses of a “S” corporation pass through to the shareholders of the corporation, and are therefore taxed only once. An “S” Corporation is not without its drawbacks. The current tax laws limit the number of investors, classes of stock, and have strict residency requirements. Shareholder liability in a corporation is limited to the shareholder’s investment in the corporation.
New Jersey’s corporate management structure is similar to that found in most states. Generally, New Jersey corporations are managed by a board of directors, who are elected by the shareholders. The directors stand in a fiduciary relationship to the corporation and must perform their duties in good faith. The board of directors of the corporation elect officers to handle the day-to-day affairs of the corporation.
General partnerships and limited partnerships enjoy “flow-through” tax treatment for tax purposes; the entity is not taxed and the partners report profits and losses directly on their personal income tax returns. Unless an agreement between the partners provides otherwise, each partner is entitled to share equally in the management of the partnership and has the authority to bind the partnership. The drawback of the general partnership is lack of limited liability protection. In contrast to a general partnership, limited partners in a limited partnership do not participate in the management of the partnership. A limited partnership must have at least one general partner and at least one limited partner. The general partner assumes personal liability for the debts and obligations of the partnership. The limited partners do not have any personal liability beyond the capital contributions they contribute to the partnership.
Limited Liability Companies
Like general partnerships and limited partnerships, limited liability companies’ (“LLCs”) profits and losses “pass through” the entity and are reflected and taxed on the individual tax returns of the members. LLCs can be managed by the members or one or more elected managers. The default rule in New Jersey is that the members manage the LLC. In this scenario, each member has the authority to bind the LLC. If the members opt to have the LLC managed by a board of managers, the members may appoint one or more managers to operate and control the business. In this instance, each manager is vested with the authority to bind the LLC.
Unlike a limited partnership, there is no requirement that at least one member of the LLC be responsible for the liabilities of the company. Furthermore, members are not liable for the debts of the LLC solely because they are members. Because of the ease of formation and its favorable liability treatment, the LLC has become increasingly popular in New Jersey.