Structuring Your Wisconsin Small Business
Entrepreneurs face an important decision to make when starting a new business—how to structure the enterprise. This article briefly explains the main options available to Wisconsin entrepreneurs, focusing on which structure is best for neighborhood businesses (also called microenterprises).
Sole Proprietorship
A sole proprietorship is a one-person business, with no legal distinction between the person and business. For a Wisconsin entrepreneur, it’s formed simply by doing business—no documents need to be filed with a state agency (although the owner may need to obtain permits or licenses, depending on the type of business).
A sole proprietor is personally liable for all business losses and debts. Sole proprietorship is therefore not recommended for most types of businesses unless the enterprise is low-risk and the owner desires ease of administration (e.g., someone who makes and sells arts & crafts at local fairs).
General Partnership
A general partnership is formed when two or more persons join to carry on a business for profit. Each owner is a general partner. As with a sole proprietorship, no documents need to be filed with a governmental agency.
A significant downside of this type of business structure is that each general partner has unlimited liability for his or her actions as well as the actions of the other general partners. Consequently, a general partnership is not advised for most types of businesses. A limited liability company is often a better option for neighborhood businesses, as we’ll discuss.
Limited Liability Companies
A limited liability company (LLC) is the optimal type of business organization for many Wisconsin neighborhood businesses. An LLC is an entity that shields its owners, who are called “members,” against business debts and losses, subject to exceptions beyond the scope of this article.
Formation of an LLC
An LLC is formed by filing articles of organization with the Wisconsin Department of Financial Institutions (DFI). The filing fee is $130. Student entrepreneurs meeting eligibility requirements can receive a waiver of the fee.
Benefits of LLCs
LLCs offer business owners multiple benefits. First, they are flexible with respect to ownership, management, and taxation. Second, they have fewer legal formalities than corporations—for example, there is no requirement to appoint directors and officers, to hold annual meetings, or to keep minutes of meetings. (Wisconsin LLCs do, however, need to file an annual report, the fee for which is $25.)
Ownership and Management of LLCs
As noted, a benefit of LLCs is flexibility with respect to ownership and management. An LLC can be owned by individuals and/or other business entities. With respect to management, Wisconsin LLCs can be either member-managed or manager-managed, a choice that must be made when filing articles of organization with the DFI.
Member-management is where the right to manage the business is vested in the members. By default, each member has equal rights to manage the affairs of the business (e.g., to negotiate and sign contracts for the business).
Manager-management is where the members designate one or more managers to manage the affairs of the business. The designated manager(s) may be members of the LLC or an outside party. An LLC owner can therefore wear two hats, so to speak—that of member and that of manager.
Either type of management structure can work for neighborhood businesses, but it’s important that roles, responsibilities, and authority are clear. It’s also advisable for LLC members to address management in an operating agreement, discussed below.
Operating Agreement
An optional legal document for LLCs, but one strongly recommended, is an operating agreement. An operating agreement is a contract signed by the LLC members addressing ownership, management, taxation, and other matters. It is internal to the business and not filed with a governmental agency.
Operating agreements can be short (e.g., a page or two) or long (dozens of pages). This site provides a simple single-member LLC operating agreement form and a simple multi-member LLC operating agreement form. It is important for LLC owners to work with a business attorney to ensure the operating agreement is property tailored to the needs of the owners and the business.
LLC Taxation
A single-member LLC is a “disregarded entity” in the eyes of the IRS and therefore taxed as a sole proprietorship by default.
Multi-member LLCs are taxed by default as a partnership, where profits and losses “pass through” the LLC itself to the members. Even though the LLC itself doesn’t owe income taxes, it still must file informational tax returns with the IRS and Wisconsin Department of Revenue and issue documents called “K-1s” to each member.
An in-depth discussion of taxation is beyond the scope of this article, but it is a critical matter for businesses. As such, entrepreneurs are strongly advised to consult with their attorney and/or accountant to ensure tax compliance.
Wisconsin requires LLCs to file an annual report. The annual report can be filed on the DFI website for $25. The due date for the annual report is the end of the calendar quarter of the anniversary month of the LLC’s formation. For example, an LLC formed on January 15 would have their annual report due on March 31.
LLCs and Venture Capital
A disadvantage of LLCs is that they are disfavored with respect to investments by venture capital firms. If an entrepreneur is committed to pursuing venture capital financing, they should discuss with their attorney if a C corporation is a better option than an LLC.
Corporations
Wisconsin has multiple types of corporations, including for-profit corporations, service corporations, nonstock corporations, and benefit corporations. To further complicate matters, corporations can be taxed in different ways, including taxation as a C corporation, an S corporation, or an exempt Section 501(c)(3) charitable organization. An in-depth discussion of corporations and the various tax regimens is beyond the scope of this article, but a few items are worth noting:
C Corporations
Unlike with pass-through taxation (e.g., multi-member LLC taxation), C corporations must pay taxes on their taxable income. Additionally, shareholders must pay personal income taxes on dividends paid out by a corporation.
C corporations are the preferred entity type for startups actively seeking venture capital financing. C corporations are also a good entity where owners desire to issue equity (e.g., stock or stock options) to employees or contractors.
S Corporation
S corporations are somewhat similar to partnerships in that income and losses “pass through” to the shareholders (owners) of the S corporation. Unlike with a partnership, however, shareholders of an S corporation who provide services to the corporation are W-2 employees—i.e., they receive a salary, and the corporation is responsible for payroll taxes.
To qualify for S corporation status, a corporation must have only individuals or certain trusts and estates as shareholders (i.e., no owners that are other businesses), have no more than 100 shareholders, and have only one class of stock.
S corporations are often optimal for small businesses that are highly profitable, as the owners might save on payroll taxes. This statement is a good discussion point for entrepreneurs to raise with their tax advisors.
Benefit Corporation
Wisconsin recognized a new type of entity in 2018: benefit corporations. A benefit corporation is a type of corporation that has a purpose of creating general public benefit, i.e., a material positive impact on society and the environment. Benefit corporations can also have more specific purposes, such as helping underserved individuals or communities, or promoting the arts and sciences.
Benefit corporations might be a good option for entrepreneurs who desire to create a business with a “triple bottom line,” i.e., one that pursues profit but also supports people and the planet.
Nonprofit Organization
The last type of business organization of note is a Section 501(c)(3) charitable organization. In Wisconsin, a Section 501(c)(3) is formed through two general steps. First, articles of organization for a “nonstock” corporation must be filed with the IRS. Second, Form 1023 or Form 1023-EZ must be filed with the IRS and tax-exempt status granted. Section 501(c)(3) organizations must have a permitted charitable purpose as set forth in the Internal Revenue Code.
Forming a nonprofit involves many other steps and paperwork, and entrepreneurs are strongly advised to consult with an attorney or legal clinic if they are interested in creating one.
