The Four Main Entity Types

American business law recognizes several forms of business organization. For CLF's practice, four are most relevant: the C corporation, the S corporation, the limited liability company (LLC), and — as a baseline for comparison — the sole proprietorship. General partnerships and limited partnerships exist and appear occasionally; they are covered briefly at the end of this session.

Sole Proprietorship

A sole proprietorship is not a separate legal entity at all. It is simply a natural person conducting business directly. No formation document is filed; no separate legal person is created. The owner owns all the business assets in their own name, reports all business income on their personal return (Schedule C), and is personally liable for every business obligation without limit.

The sole proprietorship is the default. If someone starts a business without doing anything to create an entity, they are a sole proprietor. For most CLF clients — anyone operating a real business with meaningful assets, contracts, employees, or co-owners — the sole proprietorship is almost always the wrong answer. The personal liability exposure alone makes it unsuitable for any business with significant risk.

Corporations (C Corp and S Corp)

A corporation is a separate legal entity created by filing with the state. It has its own legal existence apart from its owners (stockholders). Corporations are governed by a board of directors and managed by officers. Stockholders own the entity but generally do not run it day-to-day.

The corporation has two federal income tax regimes: the C corporation (the default) and the S corporation (an elective status). The C corp is subject to entity-level income tax; the S corp is a pass-through entity for federal tax purposes. Both are the same animal from a state law perspective — the S/C distinction is entirely a federal tax classification. Sessions 03 and 04 cover each in depth.

Limited Liability Company (LLC)

The LLC is a creature of state statute — it did not exist until Wyoming created it in 1977, and every state now has an LLC act. An LLC is formed by filing articles of organization (or a certificate of formation, depending on the state) with the Secretary of State. It provides limited liability protection to its owners (called "members") and is enormously flexible in how it can be governed and taxed. Sessions 06–10 cover LLCs in depth.

The Four Pillars of Entity Selection

When a client asks "what kind of entity should I form?", the answer depends on four core considerations. These pillars apply to every entity selection analysis and should be the first framework you reach for.

Pillar 1: Liability Protection

Every business owner wants to protect their personal assets from the claims of business creditors, employees, customers, and regulators. The question is how effectively a given entity type provides that protection.

Corporations and LLCs both provide strong limited liability protection for their owners, as long as the entity is properly maintained (see Session 01's discussion of veil piercing). General partnerships provide no liability protection for general partners. Limited partnerships protect limited partners who stay passive. Sole proprietorships provide no protection at all.

For most CLF clients, the choice is between a corporation (C or S) and an LLC — both of which provide solid liability protection when properly operated.

Pillar 2: Tax Treatment

Entity type determines how business income is taxed. This has enormous consequences over the life of a business. The main distinctions:

• Pass-through taxation (S corps, LLCs, partnerships): Business income and losses flow directly to the owners' personal tax returns. The entity itself pays no income tax. Owners pay tax on their share of profits whether or not the entity distributes cash to them.
• Double taxation (C corps): The corporation pays income tax on its profits at the entity level. When it distributes those profits to stockholders as dividends, the stockholders pay income tax again at the individual level. The same dollar of profit is taxed twice.
• Disregarded entity (single-member LLCs by default): The IRS ignores the entity entirely; the owner reports income and expenses directly on their own return as if the LLC didn't exist.

Tax treatment is often the most important factor for small business clients. Most of them cannot afford double taxation and will choose an S corp or LLC pass-through structure.

Pillar 3: Governance Flexibility

Different entity types offer different degrees of flexibility in how the entity can be structured, governed, and customized by agreement. The LLC is the most flexible — the operating agreement can address nearly any governance arrangement the parties want. Corporations are more rigid, with mandatory governance structures (board of directors, stockholder meetings, bylaws) imposed by state law.

Governance flexibility matters most in multi-owner situations. When two or three people are going into business together, the governance structure determines who has authority to bind the company, how disputes are resolved, when distributions are made, and what happens when someone wants out. A flexible LLC operating agreement can be tailored precisely to those needs; a corporation's structure is more standardized.

Pillar 4: Exit and Capital-Raising Strategy

How does the client plan to fund the business, and what is the long-term exit plan? Some entity types are better suited for certain funding sources and exit strategies than others.

• If the client wants to raise venture capital or institutional equity, a C corporation (often Delaware) is almost always required. Institutional investors prefer Delaware C corps for their well-developed law, flexible equity structures (preferred stock), and clean path to IPO.
• If the client needs to issue equity incentives to employees, LLC profits interests are often more tax-advantageous than corporate stock options.
• If the client plans to sell the business in 5–10 years, the entity type affects the tax treatment of the sale — sometimes dramatically.
• For most CLF clients who are operating businesses with no plans for institutional investment, the LLC is the most flexible exit vehicle.

Client Intake: Key Questions to Ask

The following questions — drawn from the Choice of Entity Client Checklist — help a lawyer gather the information needed to apply the four pillars to a specific client's situation. You should be familiar with these questions before sitting in on any entity selection intake meeting.

How Tax Law and State Law Classify Entities Differently

One of the most important conceptual points in entity law is that state law classification and federal tax classification are not the same thing. A business entity is formed under state law — it is a corporation, LLC, or partnership under the law of Oklahoma or Delaware. But the IRS has its own classification system that operates independently.

The IRS Classification System

For federal income tax purposes, every business entity is treated as one of four things:

1. A C corporation — subject to entity-level corporate income tax.
2. An S corporation — a pass-through entity with restrictions on ownership.
3. A partnership — a pass-through entity with flexible allocation rules.
4. A disregarded entity — ignored for tax purposes; owner reports directly.

The state law form of an entity does not automatically determine which of these categories it falls into. The IRS uses a set of regulations called the "check-the-box" rules to make this determination.

The Check-the-Box Rules

Under the check-the-box regulations (Treas. Reg. §§ 301.7701-2, -3), business entities are divided into two categories:

• Per se corporations: Entities that are automatically classified as C corporations for tax purposes, regardless of what anyone wants. A corporation incorporated under state law is a per se corporation. It can elect S status, but it cannot elect to be treated as a partnership or disregarded entity.
• Eligible entities: Entities that can choose their tax classification. LLCs and partnerships are eligible entities. An LLC with a single member is treated as a disregarded entity by default; an LLC with multiple members is treated as a partnership by default. Either can elect to be taxed as a corporation (and then potentially as an S corp) by filing the appropriate IRS form.

Why the Oklahoma LLC Dominates CLF's Practice

If you look at CLF's formation work, the overwhelming majority of entities formed are Oklahoma LLCs. This is not an accident. The LLC combines the four pillars in a way that makes it the best answer for most of CLF's clients:

• Liability protection: Full limited liability for all members, comparable to a corporation, as long as formalities are maintained.
• Tax efficiency: Pass-through taxation by default (treated as a partnership for multi-member LLCs, disregarded for single-member), avoiding the double taxation of a C corp. Can elect S corp status for payroll tax savings if needed.
• Governance flexibility: The operating agreement can be drafted to accomplish almost any governance arrangement the parties want — manager-managed or member-managed, with any combination of voting rights, distribution priorities, and transfer restrictions.
• No ownership restrictions: Unlike the S corp, the LLC places no limits on the number or type of owners. Corporations, foreign persons, and trusts can all be LLC members.
• Charging order protection: Oklahoma law limits the remedy of a member's personal creditors to a "charging order" against the member's distributional interest — they cannot force a sale of the LLC's assets or take over the membership interest. This is a significant asset protection feature.
• Operating agreement primacy: Oklahoma's LLC Act is largely permissive — the statute provides default rules, but the operating agreement overrides most of them. The parties have enormous contractual freedom to structure their relationship exactly as they need.

Key Terms — Session 02