How-To Choose A Business Entity

Which Business Entity Is Right For You? 

Upon starting your new business venture, one of the first steps you must take is to determine the legal structure of your business. Deciding on the most appropriate form requires careful consideration of both present and future business needs. This is an excellent time to seek the advice of a business or tax attorney, an accountant or other tax professional, and/or the advice of any number of public/private business counselors, such as your state's Small Business Administration (SBA), the Service Corps of Retired Executives (SCORE) or your local Chamber of Commerce's Small Business Development Center.

Each type of business entity has its own advantages and disadvantages, which should be taken into careful consideration. Your business entity can be incorporated (C-corporation, Subchapter S-corporation), or unincorporated (Sole Proprietorship, General Partnership, Limited Partnership); or it can be an "LLC" or an "LLP." Following is a brief explanation of these different entities and the advantages/disadvantages of each. While this does not include all of the reasons for or against each type of business entity, it reveals the most striking arguments.

Corporations

A corporation is an association of individuals created by law and existing as a single entity or individual, with powers and liabilities independent of its stockholders. A corporation can do business just like individuals can in a sole proprietorship. Management consists of its directors and officers, who are elected by shareholders. The shareholders can and do often change, but the business continues despite any changes in ownership status.

But be prepared to write a few checks. Incorporating can be an expensive process, especially for young, cash-strapped entrepreneurs. While the cost varies between states, expect to pay as much as $1000 for incorporation fees, plus annual state taxes. Not to mention any attorney's fees that may be required. And just in case you're in a hurry - don't be. Incorporating can be a time-consuming process. Filings can take days to weeks, depending on your home state, and sometimes up to two months when reviews by the secretary of state and county officials are required.

• Company principals are shielded from personal liability. This benefits businesses in industries with a high potential for lawsuits.
• Liability of owners/shareholders is limited to the amount invested by each. Shareholders are not personally liable for the business' liabilities, losses and risks.
• Ownership is easily transferable from one shareholder to another.
• Corporations have a continuous existence, regardless of death or change in ownership.
• Easier access to capital, which is raised by selling shares of the company to shareholders.
• A corporation allows for the adoption of various employee benefits (i.e. - the corporation's ability to fully tax deduct employee health and disability insurance premiums paid). This is not available to other types of unincorporated entities.

• A corporation is expensive and time-consuming to organize, and costly to discontinue.
• More extensive record keeping is required than for other entities.
• Corporate profits may be subject to double taxation.
• There is quite a bit of cost and hassle in the incorporation process and in complying with public agencies (federal and state) that oversee corporations.
• The hassle and potential liability from shareholder lawsuits involved in dealing with shareholders.

• Unlike other types of ownership, the shares of a corporation may be owned by a number of persons.
• A corporation can be organized by one or more persons.

Alphabet Logic: C or S?

One advantage of an S-corporation is that it does not pay federal taxes. Business profits pass through to individual stockholders, who then must report them on their individual tax returns.

Sole Proprietorships

General Partnerships

A general partnership is a business owned and operated by two or more individuals who share responsibilities, resources, profits, risks and liabilities. While many partnerships are built on mutual trust and friendship, it is strongly recommended that all partners involved prepare and sign a written agreement, outlining the business structure as well as each partner's roles and responsibilities. This becomes the governing document that will guide the partners (and keep them in line) and hopefully decrease the chance of future disagreements.

• While not as simple as the sole proprietorship, a general partnership involves few legal requirements. They are fairly easy to form and discontinue.
• Two (or more) heads are better than one, and so are multiple pocketbooks. Partners can pool their skills and resources to build a better company.
• Read our lips - no partnership taxes. Partners are individually responsible for taxes on their personal income tax returns.
• Profits and losses may be divided among partners in the manner they choose.
• Partnerships have more clout and expanded ability when looking to raise capital. 

• Each partner has unlimited liability to the business, meaning partners' personal assets may have to cover business liabilities (ouch). This liability issue can often turn a well-meaning partnership into a messy battle.
• A General Partnership is more costly to organize than a sole proprietorship.
• As with a sole proprietorship, all partners are responsible for their own actions and their employees' actions.

  If loyalty concerns you, consider partnering with a coyote. It has been documented that when one is captured, its free partner will remain with the captive until death.

• Partners' personal assets are vulnerable in the case of a lawsuit.

• Partners must report their share of partnership income on individual tax return as personal income.
• Authority and decision-making are divided among partners. (Again, how much authority should be spelled out in a written agreement.)

Limited Partnerships

Limited Liability Companies

Awarded favorable tax status in 1988 by the IRS, a Limited Liability Company (LLC) is the newest kind of business entity available to owners. The LLC generally combines the tax characteristics of a partnership with the liability benefits of a corporation. An LLC can be organized by one or more persons. The company interests are then sold like shares to the owners, or "members," of the LLC. An LLC may designate one or more managers to operate its business, or it can choose to operate under the direction of its members. The LLC's governing document is called an operating agreement, a document not unlike a Partnership Agreement.

• Easy to form, and somewhat easy to discontinue.
• Broader management base, as members can pool their talents and resources.
• Expanded ability to raise capital.
• Liability of the LLC's members is limited to each one's personal investment. Investors in an LLC do not face personal liability for the debts or obligations of the LLC.
• Flexibility. Unlike an S-corporation, an LLC can be structured to allocate the profits of the business differently among the various members, while at the same time preserving flow-through tax treatment.

• Fairly complex tax filing system.
• More restricted process of transferring ownership.

  In most US states, wedding rings are legally exempt from the list of assets in a bankruptcy case. This means that no matter how much you owe, creditors cannot seize the ring. Love may not always be binding - but the law is.

• More expensive to organize than a sole proprietorship or partnership.
• Members are generally responsible for their own actions and the actions of the business. However, unlike sole proprietorships and partnerships, members are not responsible for employee actions simply because they own the business. Members' personal assets are vulnerable in a lawsuit, although the business's assets are taken first.

• Authority is divided among the LLC's members.
• LLC members divide profits according to the operating agreement.
• Members report their share of business income on individual tax returns. The business does not pay taxes as its own entity.
• Income and losses of the business flow through to the members, and are reported only once on each one's personal income tax return.

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