Business legal structures, or the various different business types an architecture firm might use is a topic you’ll come across in Practice Management.
The best resource for studying the business formations is the Architect’s Handbook of Professional Practice (AHPP). See the Firm Legal Structures article by Jay Wickersham, FAIA. There is also a small section in Paul Segal's book, Professional Practice: A Guide to Turning Designs into Buildings. The AHPP is required reading for Practice Management. I used both books. Both of those are affiliate links, statement on that at the bottom of this page.
The Wickersham article from AHPP and the summary table show nine different types of formations. I’m going to cover the four most important business legal structures you need to know for the Practice Management exam: Sole Proprietorship, General Partnership, Limited Liability Partnership (LLP) and Limited Liability Corporations (LLC).
Once you understand those four, you can figure out PLLPs and PLLC. I’ll also touch on Subchapter S and Subchapter C corporations, but those first four I mentioned are key.
Keep in mind that the laws that guide the practice of architecture can vary from state to state. The ARE is a national exam, so you have to understand big picture items, not the minutiae of how each of these structures function. As you study, try to understand these three important terms for each business structure:
-Protection of personal assets
– tax liability
– relationships between the owners
I mention various tax forms in this post, but you DO NOT have to memorize those.
Sole Proprietor
This is the most basic business type, offering the easiest path to entry and the lowest amount of legal protection for the business owner. I’m going to cover it more in depth here than you’ll probably experience on the Practice Management Exam just because I (was) a sole proprietor and a lot of you will be or already are!
Sole Proprietor Ownership
A Sole Proprietor is a business owned by a single person. There is nothing required to start business as a Sole Proprietor, you just…start working and charging clients! If you are working for an architecture firm then have a personal side gig at night you are already a sole proprietor. If you make more than $600 annually from your side gig you are supposed to be paying taxes on those earnings. See Sole Proprietor Taxes below.
A Sole Propietor can have employees, but only one owner. A Sole Proprietor can register a business name, or a DBA (doing business as) but this does not change the legal structure of being a Sole Proprietor.
Sole Proprietor Protection of Assets
There is no separation between the business and the owner’s personal property, so the owner’s personal property is at risk in the event of a lawsuit against the company. This one is HUGE for the ARE and why I think if you see Sole Proprietor as an answer, it is probably NOT the correct choice.
Sole Proprietor Taxes
A Sole Proprietorship is a pass-through entity, so all debt and income are reported on the owner’s personal income taxes. This is done on a Schedule C, a form that accompanies your regular income tax filing. When I operated Ben Norkin Architecture as a Sole Propietorship I had a separate bank account and credit card I used for all my business transactions, even though technically as a Sole Prop there is no legal distinction. Just makes the accounting easier. Then I used QuickBooks to track expenses. At the end of the year it generated a Schedule C for me which showed my revenue, expenses and profit. That profit went on my personal income taxes as income. I also paid quarterly estimated taxes which covered my income tax for the year.
There are no tax benefits for Sole Proprietors, and there may be undesirable tax implications of being a sole proprietor as the business owner now has to pay what’s commonly known as “Self Employment Tax.” See my post about S-Corp Tax Basics to learn more, though it is NOT required reading for the ARE.
GENERAL PARTNERSHIPS
This business type often forms naturally when two or more people start working together, even if they haven’t signed anything official. While it's slightly more complex than a Sole Proprietorship, it still offers relatively little in the way of liability protection and can be risky if not properly managed.
General Partnership Ownership
A General Partnership is owned by two or more individuals. There’s no formal filing required to create one—if you and a friend start offering architecture services together and sharing profits, congratulations, you’re in a General Partnership whether you meant to be or not.
That said, it’s smart to create a partnership agreement outlining each partner’s responsibilities, ownership percentage, profit split, and what happens if someone leaves the partnership. This is just an agreement between the partners, not an official business filing with your State.
Each partner can bind the business legally, which means each partner can sign contracts or obtain loans against the company’s earnings.
General Partnership Protection of Assets
Like sole proprietorships, General Partnerships offer no personal liability protection. In fact, it’s worse—each partner is personally liable for the actions of the other partners. If your partner signs a bad contract or racks up debt, you’re on the hook too. Your personal assets (home, car, savings) can be seized to pay off business debts or lawsuits.
This is another red flag on the ARE exam—when you see “General Partnership,” assume personal liability risk is high and protection is low.
General Partnership Taxes
Like Sole Proprietorships, General Partnerships are pass-through entities. The partnership itself doesn’t pay taxes. Instead, profits and losses “pass through” to the partners, who report them on their personal income tax returns via Schedule K-1. The partnership does file a separate information return (Form 1065) to report overall income and expenses.
Each partner pays taxes on their share of the income, and yes, that includes Self-Employment Tax unless structured otherwise.
LIMITED LIABILITY PARTNERSHIPS (LLP)
A Limited Liability Partnership (LLP) is a step up from a General Partnership when it comes to protecting your personal assets. As opposed to the first two business structures covered above, an LLP is an actual business that needs to be registered with the State.
LLP Ownership
An LLP is owned by two or more partners, just like a General Partnership, but it must be registered with the state as an LLP. Partners can define how profits, responsibilities, and ownership are divided, usually in a formal partnership agreement.
LLP Protection of Assets
Protection of Assets is the big reason to form an LLP as opposed to a General Partnership. Each partner is shielded from the negligence or misconduct of the other partners. If one partner gets sued, the others aren’t personally liable. You’re still liable for your own actions and your personal assets may be at risk if you are found to be professionally negligent.
An LLP doesn’t protect the business’s assets from being used to satisfy debts or lawsuits—it’s the personal protection that matters most.
On the ARE, LLPs may be the “safe” answer when the question involves partnerships but also asks about liability protection.
LLP Taxes
LLPs are also pass-through entities. Each partner reports their share of profits and losses on their individual tax returns using a Schedule K-1, just like in a General Partnership. The LLP files Form 1065 as well. LLPs don’t pay federal income taxes directly, and partners are still subject to Self-Employment Tax on their share of earnings.
LLP VS PLLP
A Professional Limited Liability Partnership is an LLP that may be available, or required, for partnerships that offer professional services, such as Architecture. Protection of personal assets and taxes are the same between the two. In a PLLP all the partners must be professionally licensed and usually must carry their own professional liability insurance.
If it comes up on the exam just try to determine if the question is prompting you to think about licensure.
LIMITED LIABILITY COMPANY (LLC)
A Limited Liability Company (LLC) is one of the most flexible and popular business structures, especially for small firms. It offers liability protection similar to a corporation but keeps the simple, pass-through tax structure of a sole proprietorship or partnership.
LLC Ownership
An LLC can have one or more owners, called “members.” A single-member LLC is often treated like a Sole Proprietor for tax purposes, while multi-member LLCs function more like partnerships.
To create an LLC you must form an LLC with the state. It’s a good idea (and often required) to have an Operating Agreement that lays out how the LLC is run, how decisions are made, and how profits are distributed. I operate Ben Norkin Architecture as an LLC and I have an Operating Agreement with…myself? I may have even read it once.
LLC Protection of Assets
The key benefit of an LLC is in its name: Limited Liability. Members are generally not personally liable for business debts or lawsuits. Your personal house, car, and savings are usually protected if the business gets sued—unless you’ve personally guaranteed a loan, committed fraud, or some other terrible and completely unprofessional thing.
For ARE purposes, LLCs are often seen as the best balance of liability protection and ease of operation, especially for small architecture firms.
LLC Taxes
By default, an LLC is a pass-through entity:
- A single-member LLC is taxed like a Sole Proprietor.
- A multi-member LLC is taxed like a Partnership.
The LLC files Form 1065 (for multiple members), and each member receives a Schedule K-1. Members pay Self-Employment Tax on their earnings, but an LLC can elect to be taxed as an S Corporation or C Corporation if that creates tax advantages. More on S-Corp taxes later.
There are no corporate taxes by default, and the LLC structure can offer tax flexibility for small firms trying to grow or reinvest profits.
LLC vs PLLC
Same difference as we saw with LLP vs PLLP. Companies that engage in professional services, like lawyers, doctors and architects may be required to form a PLLC. The requirement here is that all Members (i.e. Owners) must be licensed professionals.
I haven’t found a good source, but I think one benefit of PLLPs and PLLCs is increased protection of personal assets from the acts of other Owners. If you know, please leave a comment below!
SUBCHAPTER S AND SUBCHAPTER C
Also called S-Corp or C-Corp, these are not stand alone business structures. A legal business structure (not sole proprietor or General Proprietor) can elect to file taxes as an S-Corp and C-Corp because it may reduce an Owner’s individual tax liability.
S-Corps are limited to 100 “stockholders” so they may be best for smaller practices. You file a Federal business return, but only to report earnings. All taxes are paid via the Owner’s (or stockholder’s) personal taxes. The benefit of an S-Corp is a portion of the Owner’s income can be classified as a distribution and is not subject to FICA, meaning you avoid the self-employment tax. I file taxes as an S-Corp, so I know more about it and have written a more detailed post about S-Corp taxes.
As far as the ARE 5.0 is concerned, a C-Corp is probably better for larger companies, as there is no 100 person limit on Stockholders. C-Corps DO pay Federal Business tax. Remaining profits are paid to Stockholders, who do have to pay income tax (and I think FICA). I am less clear on C-Corps, but I think you need them if your company is large (like 3-letter firms) and the tax benefit may be tied to lower corporate tax rates as opposed to personal tax rates. Not sure, but hey, I got through the ARE without being a C-Corp expert, and you can too!
OTHER RESOURCES
Books
Both of the books I listed above are great.
Architect’s Handbook of Professional Practice (AHPP).
Professional Practice: A Guide to Turning Designs into Buildings
Those are both affiliate links, which means if you purchase those books after clicking the link I'll get 4.5% of the sale.
Hyperfine Courses
In my PcM-PjM study assignments course I have a couple of assignments on Business Formations
Hanahan Lectures
Read more background about the Hanahan aka Schiff Hardin Lectures. This link will take you to the 2019 Schiff Hardin lectures. Check out Lecture 02 and I think Lecture 05.
EntreArchitect
Here's a good article from EntreArchitect summarizing the various business structures:
Entrepreneur Architect Academy 008 | Choosing a Business Structure for Your Architecture Firm
RELATED PRACTICE MANAGEMENT EXAM TOPICS
I have a good number of posts on my site that cover Practice Management topics. Try these two for starters:
