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Choosing your business entity

Choosing Your Business Entity

As you start a new business venture it is important to consider your options for the legal structure of your business. It is crucial to seek tax advice in making this decision because the form of entity you choose will have tax consequences.

Important questions to consider before you choose an entity are:

Are you organized and detail oriented?  This is an important question because any entity you choose will require some amount of continued review and paperwork. Be honest with yourself, choosing a business entity that you cannot maintain is not in your best interest.

What is your ultimate goal for your business? To have it provide for you and your family until you retire and then close it? Or, do you intend to pass the business on to family members? Do you intend to work for several years and then sell the business to someone you know or another entity?

What is your management style?

How will your business be funded?

If you think about these issues before you seek legal and tax advice, it can help you with making a decision.

Building a Team You Trust

Running a business is a team effort even if you are a sole proprietor.  You can’t do everything by yourself. Assembling a team is very important.  No matter what kind of business you have, you need the following advisors on your team;

  1. A lawyer
  2. An accountant
  3. An insurance agent
  4. A banker
  5. A mentor or advisor

While you are building your team, it is important to work with people you can communicate with and you trust. Ask your friends and colleagues who they use.  Call and request an advisory interview, at that time you can ask about billing policies, fee agreements.  If you don’t think you can work with the person for whatever reason, keep looking.  Do this even if you think you don’t have the time. It is much easier to find someone when you do not have an immediate issue or a deadline. Mentors and business advisors can be found through organizations such as your local chamber of commerce and S.C.O.R.E. There are many retired business people who want to volunteer. They have valuable experience that can keep you from making costly mistakes.

A Brief Overview of Business Entities

The Sole Proprietorship

A sole proprietorship is the simplest form of business to start. In most places, to start operating as a business under your own name (or a fictitious name, a domain name or a doing business as) and Social Security number, you must obtain any required state or county licenses or permits, and you’re in business. There are several disadvantages to operating as a sole proprietorship. A sole proprietorship is subject to pass-through taxation, with profits declared on the owner’s personal tax return. There is also no shield against liability, and sole proprietor’s personal assets can be taken to satisfy business debts or liabilities. By definition, a sole proprietorship has only one owner. If you have a business partner, you may be a partnership or choose a different business form, but you cannot operate as a sole proprietorship.

The Partnership

The partnership is a business entity ordinarily comprised of two or more individuals, although under some circumstances a partnership will be formed between other business entities, or between individuals and a business entity. The partnership is relatively inexpensive and simple to create and maintain, but poses tax and liability issues. It is important to consider very carefully the people you choose to be in partnership with. Depending on the type of partnership you choose, you could become liable for their actions.

General Partnership – Most partnerships take the form of “general partnerships”, where all partners have some management authority.

Limited Partnership – In a limited partnership, there are one or more “general partners” who direct the business of the partnership, and one or more “limited partners” who have no management role. Limited partners have little or no role in the management of the business, and in return for surrendering that authority their responsibility for business debts and liabilities is limited to the amount of their investment.

Limited Liability Partnership – The partners to a limited liability partnership are shielded against the debts and obligations of the partnership, and against liability for actions of their partners or employees in which they take no part and have no supervisory role.

The Limited Liability Company

A limited liability company, or LLC, is a business entity that enjoys many of the advantages of being a corporation, including limited liability, while avoiding many of the more significant burdens imposed on corporations, and while retaining many of the characteristics of unincorporated entities such as partnerships and sole proprietorships. An LLC has pass-through taxation, with members declaring their share of profits as income on their personal tax returns rate.

The Corporation

A corporation is a business entity created under state law, which stands as an independent legal “person” apart from its shareholders and directors. Accordingly, a corporation may enter into contracts, obtain loans, and pay taxes on its own behalf, and it continues to exist even after its founders or shareholders die or transfer their shares to others. A corporation’s owners or shareholders receive the benefit of limited liability for the obligations of the corporation, and are thus ordinarily shielded from the corporation’s creditors even in the event that the corporation cannot pay its obligations. Unless limited by state law or its own articles of incorporation, a corporation continues indefinitely. Ownership can be transferred through sale of stock, and the sale or transfer of a controlling interest in the corporation does not necessarily affect its management structure or operations.

C Corporation – A C Corporation is a standard business corporation, which pays taxes on its profits at the corporate tax rate under Subchapter C of the tax code.

S Corporation – An S Corporation is a corporation which has elected for its profits to be taxed in the manner of an unincorporated entity. Not all corporations can opt to become S Corporations.

Professional Corporation (PC) – A special type of corporation incorporated to perform professional services, such as the practice of law or medicine.

It is my hope that this article has helped you to think about ways to make your business both cost effective and efficient. If you have any questions, please feel free to contact me.

This article was written by Lisa Danny-Roberts, partner in the firm of Roberts and Roberts, located in Denver, Colorado.  For more information contact, Lisa Danny-Roberts at lisa@robertsandroberts.net

Posted in Business Formation.