Underwriters must consider a principal’s structure of business when determining whether to approve the principal’s bonds. Businesses have different types of ownership, and thus underwriters must determine which owner, owners, or entities need to indemnify the surety. Depending on the structure of business, these indemnitors may have limited or unlimited liability.
A single owner of a business can organize as a sole proprietorship, and the owner pays taxes on his profits directly at individual tax rates. Sole proprietorships are the simplest and most common type of business structure because they are generally easy to organize. The owner has unlimited personal liability.
Partnerships consist of two or more individuals organized as a for-profit business. Partnerships vary between general partnerships and limited partnerships. The difference between the two types of partnerships boils down to liability. In a general partnership, all partners have unlimited liability. By contrast a limited partnership may have some partners with limited liability, but at least one partner must have unlimited liability (as a general partner). The limited partners limit their liability to the amount of their investment in the business. The partners pay taxes on their share of the partnership’s income.
Business promoters organize corporations under state laws. Corporations have distinct legal status and exist separately from their owners, employees, shareholders, and promoters. The government taxes corporations as separate entities, and the corporation can continue to operate past the lives of owners and/or shareholders. Corporations limit their liability to their assets, while shareholders and owners limit their liability to the amount of their investment.
The IRS, by default, considers most corporations a “Subchapter C Corporation” because they have the characteristics described above. A “Subchatper S Corporation” differs from a C corporation in that the government taxes an S Corporation as it passes profits through to shareholders. S Corporations do not pay taxes at the corporate level, but they do have fewer tax-free benefits. Shareholders and owners of an S Corporation therefore receive the benefits of limited liability but at the expense of fewer deductions.
Limited liability companies are a common type of business entity as well. These companies’ owners, known commonly as members, limit their liability to their investment in the LLC and generally pay taxes only as they distribute income. Furthermore, the members do not incorporate the LLC so it cannot live past the lives of any of its members. If a member of the LLC dies, they surviving members must dissolve the LLC. Managing members must sign indemnity agreements on behalf of the LLC.
Underwriters carefully evaluate a business’s structure to ensure they can receive indemnification in the event of a bond claim.