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June 28, 2019

Forming a Business Entity in the United States: The Basics

One of the first steps attorneys often take when helping Canadian businesses expand into the United States is forming a US-based entity to pursue expansion activities. Below is an overview of the basic considerations and issues we address as part of that process.

General

  • The formation and regulation of business entities in the United States is primarily a matter of state law. Unlike Canada, there are no federal corporations in the United States. Corporations, partnerships, limited partnerships, and limited liability companies can be formed under the laws of any state. These entities may have their principal or other offices in another state, although they must qualify and register to do business in all states where they are “doing business.”
  • Many entities are formed in Delaware, as the business entity laws there are well developed, the annual reporting requirements are minimal, and Delaware courts have significant experience with corporate matters. In addition, Delaware is one of several states that does not have a state income tax or franchise tax. But, since corporations and other business entities need to separately qualify and register in each state where they are “doing business,” it may make sense to form the entity in the state where the business will actually be located rather than in Delaware. This needs to be examined on a case-by-case basis, and most companies prefer to minimize their reporting requirements in multiple states.
  • The timeline for formation can vary among states, but DE and NY entities can be formed in a few days or even in a few hours if absolutely necessary.
  • An entity’s name must contain certain terms. Corporations must include “Corporation,” “Incorporated,” or an abbreviation of those terms as part of their names. Limited liability companies must use “Limited Liability Company” or “LLC.” A limited partnership’s name must contain “Limited Partnership” or “L.P.”
  • The entity’s name must also be distinguishable from other names of record in the state of formation, including names for entities of another type. In cases where an entity will do business in multiple states, a name could be available in one state and unavailable in another, so, it is important to examine the name availability issue as part of the entity-formation process.

Corporations

  • Most corporations have “common shares” or “common stock.” A corporation may have multiple classes of common stock, such as voting and non-voting shares. Corporations may also have “preferred stock” that usually has a priority for dividends and may be voting or non-voting. Shares in a corporation are generally freely transferable, although agreements between shareholders of private corporations restricting transfer are common.
  • Shareholders are generally not liable for the actions or omissions of the corporation. However, some state and federal statutes provide for personal liability, including tax withholding and certain taxes. For example, New York State has an unusual statute that imposes personal liability on the 10 largest shareholders for unpaid wages.
  • Corporations suffer from “double taxation,” being taxed at the entity level on its net income as well as its shareholders being taxed on the income (dividends) they receive from the corporation.
  • Most corporations are referred to as “C corporations,” but US law does permit small, closely held corporations to elect to be treated as a pass-through entity––an “S corporation”––thereby avoiding double taxation. This option is limited, however, to corporations owned by US citizens.

Partnerships and Limited Partnerships

  • A general partnership is any association of two or more people who carry on a business for profit.
  • No state filing is needed to create a common-law partnership, and all partners are jointly and individually liable for the debts and obligations of the partnership.
  • A limited partnership is generally advisable over a general partnership, as it offers limited liability protection to its limited partners, although formation requires a state filing. Limited partnerships must have at least one general partner having unlimited liability, but the general partner is frequently considered as a separate limited liability entity. There may be any number of limited partners, and their liability is limited to their investment in the partnership. Limited partners, however, must not take any part in management of the business or this liability protection may be forfeited.
  • Unlike corporations, partnerships are not taxed at the entity level. All of the partners report their respective share of income on their own tax returns, therefore avoiding the double-taxation problem of a C corporation.

Limited Liability Companies (LLCs)

  • All states have a limited liability company law. An LLC can be operated either by its members (e.g., equity holders) or by managers elected by the members. Managers are similar to the directors of a corporation. Many LLCs are managed directly by their managers, but, sometimes, managers will elect officers to conduct the LLC’s day-to-day business activities.
  • The members enter into an operating or similarly titled agreement) to govern the operations of the company in a manner similar to corporate bylaws. An operating agreement may include restrictions on the transfer of equity and may create multiple classes of equity interests, each with their own preferences and voting rights.
  • LLCs offer a great amount of flexibility, but, from the perspective of a Canadian investor (e.g., a Canadian corporate parent starting US operations), using an LLC for a US expansion could result in paying higher Canadian taxes because Canadian tax authorities do not recognize the pass-through nature of LLCs, instead treating them as corporations. LLCs are therefore infrequently used when an owner is a Canadian individual or entity.

Case-by-Case Review

  • The type of entity to be formed, the state where it is formed, and how the entity is structured varies on a case-by-case basis and should be carefully analyzed before proceeding.

Barclay Damon LLP regularly works with Canadian clients and their attorneys and accountants to make informed decisions on these issues.

If you have any questions regarding the content of this article, please contact Rich Day, International Practice Area co-chair; Canada-US Cross-Border co-team leader; and partner, at rday@barclaydamon.com or another member of the firm’s Canada-US Cross-Border team.

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