The business entity you choose influences your business operations, taxes, and most importantly how much of your personal assets are at risk. Choose a business entity that gives you both protection of your assets and tax benefits.

Considerations for Selecting a Business Entity

In selecting your business entity, there are three primary considerations to take into account:

Convenience

  • How easy is it to form a business?
  • How expensive is it to form a business?
  • How easy is it to maintain the business

Risk/Liability

  • Are you personally liable for the business debts?
  • Personal Guarantee vs. liability for corporate debts?

Dissolution

  • Will the entity automatically dissolve, or do you need to file documentation with the states you do business in to dissolve your business entity?

The most common types of business entities are:

Sole Proprietorship, Partnership, S-Corporation, and Limited Liability Company (LLC).

Sole Proprietorship

A business owned by one person.

Convenience

  • Easy and inexpensive to form and maintain the business
  • May need to apply for a business license, etc.

Risk/Liability

  • In the eyes of the law, a sole proprietorship is not legally separate from the person who owns it
  • Very risky: personally liable for all of the businesses’ debts

Dissolution

  • As a single owner, you can dissolve your business at any time with no formal paperwork required unless you registered an Assumed Business Name (ABN), then you need to file an ABN Cancellation

General Partnership

A business owned by two or more persons.

Convenience

  • Generally easy and inexpensive to form and maintain the business (partnership agreement)
  • May need to apply for a business license, etc.

Risk/Liability

  • Very risky: personally liable for all of the business’ debts
  • Liable for actions of your partners

Dissolution

  • Automatic dissolution, unless you registered an ABN, then you need to file an ABN Cancellation

S Corporation

A business formed under a state statute.  A corporation is considered by law to be a unique entity separate and apart from its owners.

  • A corporation can be taxed, sued and bring lawsuits, and enter into contractual agreements
  • Limited liability

Convenience

The least easy to form, and it is more expensive to create than a partnership or sole proprietorship. There is more paperwork than for a limited liability company, which offers similar advantages.

  • File Articles of Incorporation with the state corporations division
  • Create corporate bylaws
  • Issue stock certificates to the initial owners

Risk/Liability

  • No personal liability for the business’s debts if you observe the formalities such as:
    • Elect shareholders, directors, and officers
    • Hold annual shareholders’ and directors’ meetings
    • Keep minutes of shareholders’ and directors’ major decisions
    • Make sure that corporate officers and directors sign documents in the name of the corporation
    • Maintain separate bank accounts from their owners
    • Keep detailed financial records
    • File a separate corporate income tax return

Dissolution

  • Not automatic. A corporation does not dissolve when its owners (shareholders) change or die. A corporation must prepare a dissolution agreement and file Articles of Dissolution with the State Business Office.

Limited Liability Company (LLC)

A form of business that offers the corporation’s protection from personal liability for business debts and the pass-through taxation of a partnership.

Convenience

  • It is more expensive to create than a partnership or sole proprietorship because of the attorney fees associated with preparing the entity’s documents
    • File Articles of Organization with the state corporations division
    • Create a written operating agreement
  • It is not as easy to form as a sole proprietorship, but it doesn’t require extensive formalities as a corporation.  Managing an LLC involves:
    • Act fairly and legally. Do not conceal or misrepresent material facts or the state of your finances to vendors, creditors, or other outsiders.
    • Fund your LLC adequately. Invest enough cash into the business so that your LLC can meet foreseeable expenses and liabilities.
    • Keep LLC and personal business separate. Get a federal employer identification number, open up a business-only checking account, and keep your personal finances out of your LLC accounting books.
    • Create an operating agreement. Having a formal written operating agreement lends credibility to your LLCs separate existence.
    • Always use and state LLC with your business name
    •  Apply for business licenses, etc., and operate the business under a “trade name”

Risk/Liability

  • Limited liability if you treat the business as a separate entity

Dissolution

  • Not automatic. An LLC does not dissolve when its members change or die. An LLC must prepare a dissolution agreement and file Articles of Dissolution with the State Business Office.

Choosing the right entity for you and your business depends largely on your risk tolerance and the tax benefits.  It is wise to consult with an accountant to determine which entity will be best suited to your tax status and then consult with an attorney to form your business entity.

For more information on business structures, visit the U.S. Small Business Administration website and the Internal Revenue Service.

Disclaimer:  This publication is intended to provide guidance regarding the subject matter covered. It is provided with the understanding that neither publisher nor author is herein engaged in rendering legal, accounting, tax, or marketing professional services. If such services are required, professional assistance should be sought.

 

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