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The Significance of Choosing the Right Entity.


Congratulations, you've decided to start your own business! Among the most important decision you'll make in that choice is the legal structure that business will take. What entity you choose will affect how much you pay in taxes, the amount of paperwork your business is required to do, the personal liability you face and your ability to raise money. And, there's no one right answer for everyone. It doesn't make sense for every business to incorporate as a Corporation just like it doesn't make sense for every business to incorporate as a Limited Liability Company (LLC) (if you have no idea what even those two are, fear not, just keep reading). What entity makes the most sense will really depend on the specifics of the type of business you are looking to open, run and grow.


Because of all the nuances and particulars, choosing a business entity is not something that should be done lightly - do not form an LLC because your "Uncle Jimmy" swears up and down it's just "the way to go." There are thousands of horror stories from people who, in hindsight, wish they had taken the time and spent some money to get expert advice from the outset.


Questions to ask include: Do you want flexibility in the management and payment structures of the business? Will the business seek venture capital funding? Do you need to protect your personal assets from the liabilities of the company? These are three of many questions that are to be considered in the formation of your business - whether you hope to sell glue, provide a cleaning service or open a school for mimes.

Corporation.

A Corporation is an entity separate from those who founded it, that is taxed, makes its own profits and is held liable for its actions as such a separate entity. It's a very common and often preferred business structure, though the paperwork and effort involved in the incorporation process may scare some small business owners away. The efforts an expense of its formation may be worthwhile, though. Through the corporate status, founders avoid personal liability - you are protecting your personal assets by creating something entirely separate from yourself. A Corporation does, however, require more extensive record-keeping and accounting practices.


With taxes, you pay personal taxes on what you choose to pay yourself from the Corporation. This could mean less money being given away on a personal level, and more money that can be left in the business to keep it going. However, the Corporation will also be taxed on its corporate earnings. This double level of taxation - at the personal and corporate levels - is common with a regular C Corporation but is often off-putting to those researching Corporate structures.


The S Corporation (a "Subchapter Corporation") is a version of a Corporation that could help avoid the double taxation situation by allowing income or losses to be passed through on individual tax returns, similar to a partnership, by taxing the Corporation's shareholders instead of the income of the Corporation itself. The creation of an S Corporation, however, is complicated and often times a business owner's goals can be just as easily met with an LLC.


Limited Liability Company (LLC).


In an LLC the owner(s) of the business have several options in how they want to structure the entity. They can opt for the tax structure of a Corporation or a pass-through structure of a Partnership of Proprietorship - allowing more choices and flexibility in taxation. However, not all states treat LLC taxation similarly, so choosing the right tax approach in an LLC is another area served by consultation with an attorney. No matter the tax structure, your personal assets are still given some protection with an LLC should your business fail.


LLCs do have cons as well. For instance, they are tough if you have several investors or raise public money, since you don't have shares or stock certificates to offer. Similarly, if you give a percentage of ownership to outside investors, you must decide whether they'll be managing members. Additionally, while most states require only one member in an LLC (you), if you live in Massachusetts or the District of Columbia, you must have two members. Moreover, unlike with a C Corporation, you can't deduct the cost of benefits to your or your employees with an LLC. Still, because of the way an LLC takes from the benefits of the Corporation and Partnership structures, it is becoming an increasingly popular choice among new businesses.


Cooperative.


Not as well known, a cooperative is a business or organization owned by and operated for the benefit of those using its services. Profits and earnings generated by the cooperative are distributed among the members, also known as user-owners.Typically, an elected board of directors and officers run the cooperative while regular members have voting power to control the direction of the cooperative. Members can become part of the cooperative by purchasing shares, though the amount of shares they hold does not affect the weight of their vote. Cooperatives are common in the healthcare, retail, agriculture, art and restaurant industries. A cooperative operates as a corporation and receives a "pass-through" designation from the IRS. 


​In Conclusion


Don't let the length of this or other articles on the internet fool you. Even if you've read to the bottom (thank you, by the way, in this social media age, for having the patience and interest to read this far), and feel as if you've gotten all the information there is, believe me when I saw "no, no you have not." There are nuances, state specific information, considerations based on the unique circumstances of your business and much more that you should consult a professional about before making a final decision.

Types of Business Entities.


Sole Proprietorship.


The simplest of the business entities available, a Sole Proprietorship is often the default option for new business owners because it is easy to create and simplifies the tax process come April (the owner includes profit and loss on his or her own tax record) because the entity and you are basically one and the same. The drawback to there being now wall between you and your business is that it means the business is tied to your personal assets. If the business fails, you could lose your property, savings and other personal assets to pay creditors and debts. You may also be subject to a self-employment tax on the profits your business makes due to the structure of this entity.


Partnerships.


Partnerships can vary. They can, for instance, be general or limited (called an LLP). A General Partnership is similar to a Sole Proprietorship in features, it just entails more than one person as owner of the business. It too is often the default option for new businesses with multiple owners. Like the Sole Partnership, a General Partnership ties the business and personal assets of the partners together, bringing with it simplicity in tax season but the same exposure of your personal assets.


A Limited Partnership, in its structure, works to remedy that exposure. In a Limited Partnership, allows business owners to become "Limited Partners" instead of "General Partners," thus building a wall between their personal assets and business assets - limiting the reach of creditors and debts of the business into the former. However, this wall limits not just your personal liability but also your say in the Partnership. In order to get some of the financial security that come with being a Limited Partner, you surrender your right to personally manage the affairs of the business.


In both a General and Limited Partnership, there's always the question of ownership of ideas and processes where your business is built on such things. The lack of protection with these entities means that if one partner walks away, they may take whatever idea or process you business is based on with them.

Learn About

Maria Krishtul

MK Law's

Principal

Attorney

Starting a Business:

How to Choose the Right Business Entity

April 2016

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