How a Business Law Firm Will Help You Choose the Right Business Entity
There is more to entrepreneurial success than vision, passion, and hard work. Before you even get your business idea off the ground, you need to think very carefully about what sort of legal structure you want to use for your enterprise. These are legal entities you can choose from.
Sole ProprietorshipThe simplest and most common way to organize a business, a sole proprietorship is not a legal entity at all, but instead indicates that the owner and their business are one in the same. Even if you create a fictitious name for your business, the name will be recognized solely as a trade name rather than the name of a distinct entity. Thus, any business contracts the owner signs will be in his or her name, and any checks they receive as a sole proprietor will be in their name.
Because the owner is indistinguishable from their business, taxation is simple and the cost and time to set up is minimal. Owners can freely mix their business and personal assets, will not have to pay any unemployment tax on themselves, and will not have to worry about the formalities of other business structures, such as annual meetings and reports.
On the other hand, sole proprietorship suffer one major drawback: the aforementioned lack of separation between the business and its owner means that in the event that the business is sued, indebted, or suffers some other liability, the owner is subject to unlimited personal liability. As a sole proprietor, there will be no protection of your personal assets from business-related disputes.
PartnershipIf you plan to go into business with one or more individuals, you may want to consider a partnership. This business entity is structured around two or more people who agree to share in the management, profits, and losses of the business.
Partnerships come in two forms: general partnerships, in which the individual partners manage the company and collectively assume responsibility for its obligations and debts, and limited partnerships, which also have general partners that operate the business, but additionally include limited partners who serve only as investors and have neither control nor liability over the company. (Usually, a limited partnership is not ideal unless you plan to have a lot of passive investors, since its tax filings and corporate structure is complex.)
A major benefit of a partnership is that it is not subject to federal tax: business income is passed through to the individual partners, who are taxed at their own individual tax rates. They are also structurally versatile, allowing owners to apportion ownership, voting rights, and income rights in a variety of ways. The relative simplicity of a partnership makes it fairly inexpensive and easy to start up.
However, as with a sole proprietorship, the biggest issue is personal liability: all general partners are liable for the partnership's debts and obligations, and - if the partnership agreement permits - each partner can act on behalf of the whole partnership, making decisions and taking out loans that will affect everyone else.
CorporationPerhaps the most familiar type of business organization, a corporation is a separate entity from its founders and operators that nonetheless handles the responsibility of the business. A corporation is recognized as a distinct legal person that can be taxed, sued, and held liable for its actions separate from its employees, investors, and owners. Any of its debts or losses are its own, thus protecting the business owner from personal liability.
Additionally, a corporation can keep some of its profits untaxed. Unlike a sole proprietorship, it also has the advantage of being able to raise funds, such as through the sale of stock. Thanks to their legal personhood, corporations can continue to exist even if a shareholder passes away or can no longer play an active role in the business.
As with other business entities, corporations have their disadvantages. Chief among them is the greater expense and complexity of forming and operating a corporation. Since it is an independent entity for legal purposes, it comes under greater regulatory and tax scrutiny, which in turn means more money for accounting and tax prep. Corporations are also subject to double taxation, which means that in addition to having its income taxed, the earning distributed to shareholders via dividends are also taxed at an individual tax rate. There are certain ways to mitigate this tax burden, including opting to form an S Corporation, which is distinct from a standard corporation (also called a C Corporation) in its pass-through tax structure and other features. A qualified legal expert can lay out the pros and cons of both types of corporations and whether incorporation is the best option for you.
Limited Liability Company (LLC)LLCs are an increasingly popular option among small business owners because they offer a balance between a corporation and partnership. As the name suggests, this entity is ideal for protecting owners from liability: as in a partnership, earnings and losses are passed through to the owners and listed on individual tax returns. But like a corporation, business owners also enjoy personal liability protection - only the capital paid into the business is at risk.
Other benefits of an LLC include a simpler tax arrangement (no need for a separate business tax return), versatile management options (a member can be a person or other business entity), and flexible distribution of profits and losses (income does not have to be distributed proportionally).
Now the downsides: first, LLCs do not have stock, making it difficult to raise public funds without giving outside investors managing membership. Second, LLCs aren't the best when it comes to providing fringe benefits - unlike a C corporation, you can't deduct the costs of the benefits, nor do you have the option to offer stocks as incentives to employees. Finally, LLCs require more time and paperwork than a sole proprietorship, from filing the Articles of Organization with the state, to filing annual reports.