Choosing the Right Business Entity

What type of entity should I use?

There are four choices for organizing an entity; (a) sole proprietorship; (b) partnership; (c) corporation; and (d) limited liability company. Each entity has advantages and disadvantages.

What is a Sole Proprietorship?

Sole proprietorship is the simplest way to operate a business. You are the owner and operator of the business with complete control. Benefits of operating as a sole proprietorship include low costs and no formal legal requirements. If you want to use an assumed (fictitious) name for your business, you must file a Business Registration Certificate in each county you do business.

The major drawback of a sole proprietorship is your personal liability for all the debts and obligations of the business. If your liability insurance does not completely cover a claim, your personal assets can be exposed to a claim by the injured party.

What is a Partnership?

Partnerships are the oldest form of entity by which two or more people do business. There are no formal legal requirements to create a partnership, although a written partnership agreement is always recommended and can help resolve any future disputes. Like a sole proprietorship, you must file a Business Registration Certificate if you wish to use an assumed name. Partnerships do not pay corporate taxes and all income and losses flow through to each partner.

The greatest disadvantage of a general partnership is that all partners are jointly liable for the partnership’s debts.

Is a Corporation right for me?

The most important benefit of incorporating a business is the protection of personal assets from most of the liabilities of the business. A corporation is a separate legal entity and, if properly organized and operated, creditors of an incorporated business are not entitled to sue the owners of the business for the corporation’s debts.

There are other benefits as well, such as centralized management, continuity of life, the ability to raise additional capital and easy transfer of ownership. Corporations can be treated as an “S” or a “C” corporation for tax purposes. Eventually taxable income of the C corporation may be subject to a second tax at the shareholder level (double taxation verses flow through tax treatment).

Income generated by the S corporation is taxed at the shareholder level and usually the income is taxed at the rates applicable to individuals. Losses are passed through to the shareholder and may be available to offset other income of the shareholder. Capital gains realized by the S corporation are taxed at the capital gains rates applicable to individuals.

There are costs to consider: the cost of filing annual reports and the cost of conducting annual meetings. It is also necessary to file a separate tax return for the corporation and the corporation will need separate bank accounts. Also there are limitations of shareholders of an S Corporation (individuals, some trusts, and single member LLCs).

Is a Limited Liability Company (LLC) right for me?

Like a corporation, if properly formed and operated, a LLC can limit the liability of its Members (similar to shareholders in a corporation) for company debts. Like a partnership, LLCs are not taxed at the company level and allow for great flexibility in the management structure of the company. LLCs are often compared to subchapter S corporations because of the similar tax treatment, but do not have the ownership restrictions of an S corporation. Assets that will appreciate (e.g. real estate) should be owned through an LLC to protect against possible reorganization problems. Removal of appreciated assets does not cause gain, unlike a corporation.

Related Services:Protection of Limited Liability Status; Business; Business Entity Organization

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