How to Choose the Right Type of Entity for Your Business
You have your business idea and goals in mind. You know what service or product you want to sell. What is next in understanding which entity is the right choice for you and your business needs?
Before registering the entity, a business owner must understand the liabilities that he or she may face. Unlimited liability requires the proprietor to assume responsibility for any debts, liabilities, obligations, or lawful expenses for which the business is responsible. Unlimited liability for a business that does not have a corporate or limited liability status may require the owner or any successors to sell personal assets to repay debts. Limited liability protects the owners, partners, and stockholders from personal responsibility to repay company debt. In other words, when a business owner uses a limited liability form like a corporation or limited liability company, creditors of the business may only pursue the corporate assets rather than the assets of the individuals who own the company.
Know your options for asset protection!
The first step in becoming a S-corporation is to determine the state in which to locate the main business or headquarters. The owner must file a corporate charter to receive corporation status. Then after the business is considered an official corporation, the owner may file for S-corporation status. The primary advantage to S-corp status is that there is no double taxation. Shareholders are taxed instead of the business. Taxation varies from every state and owners should be aware of how the local state treats S-corps before filing for this type of entity. An owner should also check with their tax accountant to review any special IRS regulations.
In the creation of C-corporations, there is an unlimited amount of stockholders. This allows for large investments and substantial growth. Limited liability is also applicable to these corporations. C-corps are subject to double taxation which means that both the business’ and the shareholder’s dividends are taxed.
Limited Liability Company (LLC)
In a limited liability company, there is protection of the individual assets for all those that own the company. Since only owners have units in the company, they are taxed based on the profits or losses when they file their personal tax return. Owners of the LLC can be individuals and even other corporations or LLCs. The longevity of an LLC can become jeopardized if an owner decides to leave since many states automatically terminate the LLC status.
Limited Partnership (LP)
A Limited Partnership is comprised of two types of partners: limited partners and general partners. Limited partners, as suggested by the name, have limited liability for the debts of the LP. Protection of personal assets can be achieved, even though they can be sued. Limited partnerships are a popular type of entity due to the lack of risk for investors. Limited Partners contribute their assets to become owners of the company with no participation. In contrast, general partners are personally liable for debt obligations while actively engaging in management.
Other Forms of Business Ownership
A business owner is automatically a sole proprietor if there are no other owners or shareholders in the business. This owner is responsible for everything that the business does. Since the owner is the only one involved, the owner, instead of the business, is taxed on the business’ income. This is considered the owners’ income tax. Though a sole proprietorship can be stressful with mounting pressures due to raising capital and unlimited liability, it can be easy to start a sole proprietorship and is simple to operate as the owner has complete control.
Professions that require a license to practice are usually business entities that are registered as professional corporations. Many states also require a license to register a business as a professional corporation. Though some professional corporations may also be registered as professional limited liability corporations, they can still be sued for malpractice. The corporation is taxed accordingly depending upon if it has LLC status.
A not-for-profit can generate income and make profits. The profit is returned to the company instead of being distributed as dividends to the shareholders. Not-for-profits can also apply for tax exempt status to avoid paying various state and federal taxes. The tax exempt status is not valid until it has been approved by the IRS. The entity is also allowed to file an Application for Recognition of Exemption. This allows anyone to make a tax deductible donation which is more appealing to donors. This application must also be approved by the IRS before it is valid. Some states require more paperwork for any type of tax exemption application. Processes should be reviewed by the owner before paying taxes or distributing forms to donors.
It is highly recommended to obtain legal advice and counsel with a qualified attorney when beginning a new business. Our skilled attorneys can guide you through the process and help you decide which entity is best for you. With over 25 years of combined experience, our attorneys will handle all the steps in the process to assure your entity is registered correctly and that your interests and assets are protected.