Your choice of business entity determines asset liability and protection, ease of day-to-day functioning, and taxation. Thus, it’s imperative that you choose the right entity for your business.
Setting up a new business is a major step in your life and you should always consult with a qualified business law attorney before you do so. In this article, we will provide some basic information on how to choose a business entity to get you started in the right direction. We will explore the sole proprietorship, partnership, limited liability company, and corporation.
A sole proprietorship is the default entity for people who start a business on their own. It’s created in a blink of an eye and can be dissolved that quickly as well. In addition, there are no legal set up fees, ongoing entity fees, or special taxation issues – and no legally required day-to-day reporting requirements.
As you might imagine, those sole proprietorship benefits are a huge draw to new entrepreneurs. However – and it’s a very big “however” – a sole proprietorship has ZERO asset protection. This means that all of your personal assets are on the line for debts of the business and all of your business assets are on the line for personal debts. There is no separation between business and personal assets.
A general partnership is the default entity for two or more people who start a business together. Like the sole proprietorship, it can be created in a moment – at the conference table – or at a back yard barbecue with a cold brew in hand.
There are no required legal fees*, ongoing entity fees, or special taxation issues – and no legally required day-to-day reporting requirements. General partnerships have the same downside as sole proprietorships – absolutely no asset protection. If you or a partner gets sued, you can lose everything you own.
*Legally, you don’t need a lawyer to set up a general partnership; however, in practicality, you do – you need a formal partnership agreement to open a bank account or apply for a loan. A formal partnership agreement also outlines the rights of the partners during the partnership and beyond.
On the other hand, a limited partnership does – as the name implies – limit liability. Each partner’s liability is limited to the amount he or she has invested in the business itself –personal assets are not at risk in a business related lawsuit.
There must be a formal written partnership agreement. Otherwise day-to-day operations are simple – and taxes are filed on the partners’ individual income taxes.
The limited liability company (LLC) tends to be the “go to” entity for most small businesses. It has many of the benefits of both the partnership and corporation but at the same time, simplifies the day-today operations.
Most importantly, the LLC offers asset protection. This means that your personal assets can’t be taken in a business related lawsuit (if your LLC has more than one member). If you are creating the business on your own, ask your business attorney whether the LLC is a good entity for a single member – the law appears to be flux.
The LLC does require an informational tax return – although profits and losses are shown on the members’ individual tax returns. There are no day-to-day reporting requirements.
Though LLCs have become the “go to” entity for small businesses, larger businesses may benefit from the S or C corporation. Corporations have a long history of asset protection – though formal set up, operating procedures, record keeping, and tax reporting are required.
Ask your business attorney about the downside of double taxation should you choose the C corporation for your business
A qualified business lawyer will help you choose, set up, run, and wind down the business entity that best fits your individual situation. Along with entity issues, every business needs to be aware of licensing, insurance, labor law, immigration law, tax law, and intellectual property law considerations.