Choosing the right business entity allows you to achieve maximum protection for your personal assets, and you can avoid the multiple layers of taxation by the state and federal governments. Equally important is the ability to attract investors, and financing is largely determined by the type of business entity you choose. It will also determine whether your business can continue to operate after your death. How to choose the right business entity depends on your assessment of how these considerations relate to your objectives for building a successful business with the least amount of potential personal liability. The entity choices available include the following categories:
A Sole Proprietorship
This is a business owned by one person, and it has no legal distinction from the owner, and it requires no government filings other than a statement about the owner who is operating the business. This is an inexpensive way to start a business. All income and expenses are reported on the owner’s personal tax filing. The drawbacks are 1) No personal liability protection and 2) No automatic transfer of ownership upon the death of the owner.
Corporations are legal entities and are separate from its owners. These entities require the creation of more legal documents, and the ownership is vested in more than one person. Management includes a board of directors, and owners include shareholders who elect the directors. The board of directors approves the appointment of officers who run the business.
Business corporations can be formed by using one of the several types of corporation structures which differ in the way each functions. The C and S Corporations have advantages and the LLC also has distinct advantages. The C and S Corporations are taxed differently, and this is one of the primary considerations in selecting one of these entities. One or more owners can create an LLC or a Limited Liability Company. An LLC offers greater flexibility in the management of the business. A board of directors is not required. Each of these entities provides personal protection for the owners and shareholders. The multiple benefits and disadvantages of each corporate entity should be discussed with an experienced business and tax consultant.
A business entity can also be selected from the two primary types of partnerships. The two types are the general partnership and the limited partnership. A general partnership is the easiest entity to create second only to the sole proprietorship. Since this entity involves two or more people, it is essential that the duties of each partner be stated in writing as well as the benefits due to each. Each partner is subject to personal liability. The profits and losses are reported on each partner’s personal income tax as outlined in the partnership agreement.
The limited partnership is a more formal entity requiring that the partnership agreement is filed with the state. Limited partners are not personally liable for the debts, but they cannot be involved in the daily management of the business. This is a good method to interest investors.