If you’re starting a business, you are likely quite busy with forming your business plan, branding, creating a website, securing banking and/or financing, and myriad other issues. For many of our clients, their business is one of their most valuable assets that will provide for their family not only during life, but when the client passes away as well. As you’d expect, establishing and maintaining a successful business requires a significant investment of both time and capital. A thoughtful and thorough business plan is essential when starting up, and it will consider, among other things, revenue and growth, partners and employees, taxes, and protection from losses and threats, including lawsuits.
Aside: Did you know that according to the U.S. Financial Education Foundation, more than 40 million lawsuits are filed in the United States each year? As a point of reference, there are only 31.5 million SECONDS in an entire year!)
This short article gives you the 101 on choosing the right business entity, helping you form a solid foundation.
So, what are they?
Sole Proprietorship: A sole proprietorship is a relatively simple and common form of business ownership in which an individual (not a group of individuals) operates and owns the business entirely. The owner assumes all legal and financial responsibilities, and there is no legal distinction between the business and the owner. This means that while the owner has full control over the business’s operations and decision-making, she also has unlimited liability with respect to the business operations. Sole proprietorships are subject to pass-through taxation, meaning the business itself is not taxed. Rather, the owner reports income or loss from the business on their personal tax return, typically on a Schedule C .
Partnership: When two or more people agree to do business together, formally or informally, this is called a partnership. With multiple owners, a partnership is formed, de facto, even if no paperwork is filed with the state or agreements signed between them. Partnerships can be a good entity choice as they allow for the pooling of resources, skills, and expertise, which can lead to increased revenue (and profits) and offer management flexibility.
In a typical partnership (a general partnership), all owners share equal responsibilities and liabilities in running the business. Each partner contributes to the business’s operations and shares both the profits and losses equally.
In contrast, a limited partnership involves two types of partners: general partners and limited partners. General partners have unlimited liability and actively participate in managing the business, just like in a general partnership. However, limited partners have limited liability and are typically not actively involved in the day-to-day operations. They primarily contribute capital to the business and share in the profits but are shielded from liabilities beyond their investment.
Corporation: Larger businesses may choose to be a corporation. A corporation is owned by its shareholders and operated by a board of directors (who may or may not also be the shareholders). A corporation is a separate legal entity from its owners, which means the corporation can engage in business and contacts, as well as own property, in its own name. A corporation offers several benefits, including limited liability for its shareholders, meaning their personal assets are protected from the company’s debts and legal obligations. Additionally, a corporation has a perpetual existence, allowing it to continue operating regardless of changes in ownership or management (i.e. when a shareholder passes away). Corporations also enjoy certain tax benefits and deductions not available to other business structures. Within this category, business can choose to be taxed a C Corp (where the business pays taxes) or an S Corp (where the shareholders pay the tax). There are benefits to each that should be considered by your legal and tax professionals when starting your business.
Limited Liability Company: A Limited Liability Company, or, an “LLC,” combines enhanced liability protection – even better than that of a corporation – while maintaining the flexibility and tax benefits of a partnership. In short, while an owner’s personal creditor can attach the owner’s stock, such creditor cannot attach the owner’s LLC interest. Another benefit of an LLC is that it can even be taxed as a C Corp or an S Corp if the tax structure fits and certain elections are made timely.
Be cautious with LLCs, however. Some suggest that an LLC requires fewer formalities than a corporation. We disagree. There are statutes that govern LLCs which must be followed, and the creation and honoring of an LLC Operating Agreement is imperative to preserve the enhanced asset protection that an LLC can provide.
If you’d like to talk to a Board Certified Estate Planning Attorney about setting up your business, including which structure is right for you, send us a note. We’re happy to help. Let’s Talk!