sign in sign up
<<
Home , Limited liability, Sole proprietorship, S corporation, Worker cooperative

Choosing a Entity A Guide for Worker When forming, worker cooperatives have an important choice to make regarding their legal entity. The business entity types most commonly used by worker cooperatives are the - erative (which is not available in every state), the (LLC), and the . Worker cooperatives may also choose to operate as an or general . Each entity type has implications on important issues including taxa- tion, , and access to capital. Keep in mind that entity choice is not a permanent decision. A worker may de- cide to change its entity type as the needs of the business change. This resource is intended to give a brief overview of the entity types and lay out the issues worker cooperatives may want to consider when choosing which is the best fit for the business at whatever stage it is currently in.

Entity Types • Cooperative : Twenty-three states to C corporations in that they are a separate have statutes that enable to in- legal entity from their owners. However, S cor- corporate as a cooperative. Some states have porations elect to pass through their income and worker cooperative specific statutes, while losses to their owners for federal tax purposes. others have a consumer or general cooperative • General : A is a statute that worker cooperatives can incor- business entity with more than one partner (dis- porate under. These statutes create a corpo- tinguishing it from a ). Each rate form that is owned and controlled by its partner contributes to the business and shares members, and which operates for their benefit. in the profits and losses of the business. Statutes vary in their specificity, but often have guidelines around issues such as entity forma- • LLCs: An LLC is a business entity that provides tion, capital accounts, governance rights, mem- limited liability to its owners, but has the flex- bership requirements, and more. ibility to operate like a general partnership. In an LLC, owners are referred to as members. • C Corporations: C corporations are business en- tities that are a separate legal entity—and that • : A benefit corporation is a are taxed separately—from their owners. of corporation for socially conscious businesses, which is currently available in more • S Corporations: S corporations are very similar than half of the states as well as the District of

The Democracy at Work Institute • 415-379-9201 • http://institute.usworker.coop Columbia. that register as a ben- (once at the entity level and once through divi- efit corporation maintain their tax status as a dends to individual owners)? Is there a minimum C corporation, S corporation, LLC, etc., but have annual business tax? additional protections and responsibilities relat- • Formation costs and requirements: What are ing to their social purpose. the filing fees and how burdensome are the requirements? Issues to Consider • Administrative requirements: What are the Determining which entity type is best for your ongoing administrative requirements, such as worker cooperative depends on the character and annual reports, board elections, annual meet- goals of the business (as well as which entities are ings, etc.? available in your state). There are many factors to consider, including the following: Taxation Elections with LLCs • Personal liability: Are owners personally liable in the case of a lawsuit against the business? Worker cooperatives that choose to operate as an LLC have another decision to make—how to • Entity name: Can the call itself a be taxed. There are two primary ways to tax an cooperative? LLC: as a partnership or as a corporation (either a • Demutalization: How easy is it for the organiza- C corporation, S corporation or T corporation). tion to revert to a non-cooperative structure? If the business is taxed as a partnership, the • Retaining capital in the business: How easy is members of the cooperative are taxed on all the it to retain capital in the business for growth or profits of the business, including those that stay other purposes? in the company. While this avoids double taxation • Employment law: Are workers presumed to be and makes for simpler , it also creates employees under this corporate form, such that a disincentive for re-investment of profits in the labor apply? This is especially important in company. Additionally, any profits retained in the context of businesses that hat cannot pay the business are technically owned by individual minimum wage from the onset or prefer having members, instead of the cooperative itself. As the staff structured as owners as opposed to a result, an LLC taxed as a partnership may not employees. be the best choice for cooperatives that have reached a certain stage of growth. • Capital access: To what extent is the business entity friendly to outside investment in a way However, the business can move relatively eas- that maintains cooperative principles? ily between being taxed as partnership versus a • Democratic : How well is the entity corporation or change to another entity type with suited to support a democratic ownership struc- the help professional advisors. LLCs taxed as a T ture? or S corporation, for example, avoid double taxa- tion, but allow for the flexibility of a membership • Scale and growth: What issues arise when a structure instead of issuing . A cooperative worker cooperative incorporated under this en- may choose to start out as an LLC taxed as a tity type experiences significant growth? partnership and change its status as it grows. • Entity taxation: Does the entity get taxed twice

DISCLAIMER: This resource is for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem.

The Democracy at Work Institute • 415-379-9201 • http://institute.usworker.coop Worker Cooperative Choice of Entity Chart Issue area Cooperative corporations C Corporations S Corporations LLCs (Taxed as a Partnership) General Partnerships

Personal liability Members are generally not personally liable. Shareholders are generally not personally liable. Shareholders are generally not personally liable. Members are generally not personally liable. Partners are personally There is no limit on liability for partners liable. g in a general partnership. Partners’ Entity name States with cooperative statutes generally require Cannot call business a cooperative if a cooperative Cannot call business a cooperative if a cooperative Cannot call business a cooperative if a cooperative Cannot call business a cooperative if a cooperative personal assets are at risk. incorporation under the statute to use the word "coop- statute prevents it. statute prevents it. statute prevents it. statute prevents it. Cooperative corporations can erative" in the business name. g always be called a cooperative. Demutalization In many states, statute includes disincentives for Must structure a "poison pill" into bylaws to disincen- Must structure a "poison pill" into bylaws to disincen- Must structure a "poison pill" into operating agree- There is no separate legal entity from partners. If Cooperative corporations often have demutalization. tivize demutalization. tivize demutalization. ment to disincentivize demutalization. partners leave, the organization ceases to exist. g long-term cooperative structure Retaining capital in the Cooperative orporations can retain capital in the busi- C corporations can retain capital in the business with- S corporation owners must pay taxes on business LLC members must pay taxes on business income There is no separate legal entity from the partners to built into the form. business ness without tax consequences for worker-members. out tax consequences for workers. Retained earnings income whether it is retained in the business or whether it is retained in the business or allocated/ retain capital in. Retained earnings are taxable at the entity level. are taxable at the entity level. distributed to them. This makes retaining earnings distributed to them. This makes retaining earnings difficult, although there are work-arounds. difficult, although there are work-arounds.

Employment law Employment law presumed to apply, but this may not Employment law presumed to apply. Employment law presumed to apply Employment is not presumed to apply. Employment law is not presumed to apply. LLCs are the best form for entities always be the case. g that prefer having owners to Capital access Possible to raise capital through preferred equity Entity type is built to encourage outside investment Entity type is build to encourage outside investment May sell interests, but perceived as not as favorable No mechanism for outside investment. Partners employees. depending on cooperative statute. Generally more through stock structure. through stock structure, but has limitations on the to capital as C or S corporation structure. provide capital. C corporations are designed to difficult (or perceived as more difficult) than with a C number of owners and type of stock that can be is- g raise outside capital and have the or S corporation. sued. structure to allow for preferred, Democratic ownership Form is designed to give members voting/ gover- Can issue multiple classes of stock and unlimited With only one class of stock permitted, financial Very flexible structure. May sell interests to outside No outside investment mechanism, but partners can non-voting shares. nance rights that are independent from financial number of shareholders. Can use multiple classes of rights and voting/ governance rights are tied together investors and separate voting/ governance rights from structure voting/ governance and financial rights rights. stock to distribute voting/ governance rights separate through stock ownership. financial rights. however they please. Cooperative corporations are from financial rights. g designed for democratic ownership. Scale and Growth Growth capital may be difficult, as cooperative C corporations are easily able to grow. However, S corporations only allow one class of stock and a Difficult at a larger scale because income is taxed to A general partnership would have to form a separate corporations are perceived as less friendly to outside democratic structures put in place early may not be maximum of 100 shareholders. Cooperatives that individual owners (usually at a higher rate) instead legal entity to scale. investment than stock corporations. However, the sufficient to maintain worker cooperative principles plan to expand beyond 100 members would have of the corporation. Also perceived as less friendly to structure maintains democratic structure through as the company grows. Must revisit and put stronger to convert to another entity type (unless using an investment. growth without adjustment to bylaws. structures in place. plan). Entity taxation Entity-level taxation for retained earnings. However, Double taxed. Taxed both at the entity level and when No entity-level tax. Avoids double taxation by passing As a default, taxed like a general partnership: no No double taxation, as there is no separate legal avoids double taxation to some extent, as allocations owners are issued . through income to owners. entity-level tax, avoids double taxation by passing entity from the partners. C corporations are the only entity to members’ accounts are not taxed, using Sub- through income to owners. However, can elect to be g that is double taxed. Chapter T tax status. taxed as an S, C, or T corporation. Formation costs and State-specific filing fee, must register with the state. State-specific filing fee, must register with the state. State-specific filing fee, must register with the state. State-specific filing fee, must register with the state. No filing fee, no need to file. Cheapest, least burdensome form in requirements g terms of formation. Administrative State specific requirements that are typically as least Requirements around the election of board members, Requirements around the election of board members, Minimal administrative requirements. Minimal administrative requirements. LLCs have very few administrative requirements. They can be great for requirements as extensive as C or S corporation requirements. annual meetings, annual reports, and more. annual meetings, annual reports, and more. g start-up businesses.