Why Form a Business Entity?

All legal and tax professionals agree, if your business is not incorporated you may be throwing away thousands of dollars in tax savings and deductions.

In addition, and most importantly, all of your personal assets such as your home, cars, boats, savings and investments are at risk and could be used to satisfy any law suits, debt or liability incurred by the business. Forming a business entity can provide the protection and tax savings needed to give you peace of mind and make your business even more successful and profitable. Some of the benefits include:

Liability Protection: Properly forming and maintaining a corporation will provide personal liability protection to the owners or shareholders of the corporation for any debt or liability incurred by the business. Personal liability of the shareholders is normally limited to the amount of money invested in the corporation.

Tax Advantages: Another important benefit is that a corporation can be structured many ways to provide substantial tax savings. You can minimize self-employment taxes and increase the number of allowable deductions lowering the taxes you pay on the income of the business. Many corporations structure retirement and tax deferred savings plans for their owners and employees which can provide even greater tax savings.

Raising Capital: Sale of stock for the purposes of raising capital is often more attractive to investors than other forms of equity sales. A corporation can also issue Corporate Bonds to raise capital for expenditures without compromising the ownership of the business.

Types of Business Entities

When deciding which entity to form it is necessary to consider short and long term goals of the business, the nature of the business and the benefits associated with each type of entity. We do suggest that the selection of a business entity be done with the assistance of a lawyer. The following are several different types of business entities:

  • Sole Proprietor
  • Corporation
  • Partnership
  • Limited Liability Company
  • Limited Partnership
  • Limited Liability Partnership
  • Hybrids of the above

The two most common limited liability entities that we recommend are:

Corporations

One of the primary advantages of incorporation is the limited liability the corporate entity affords its shareholders. Typically, shareholders and directors are not liable for the debts and obligations of the corporation; thus, creditors will not come knocking at the door of a shareholder or director to pay debts of the corporation. In a partnership or sole proprietorship the owner’s personal assets may be used to pay debts of the business. Maintaining the limited liability of a corporation requires that the shareholders and directors follow all the rules of governance, including holding annual meetings and maintaining meeting minutes.

Advantages:

  • A corporation’s life is not dependent upon its members. A corporation possesses the feature of unlimited life. If an owner dies or wishes to sell his or her interest, the corporation will continue to exist and do business.
  • Retirement funds and qualified retirement plans (like 401k) may be set up more easily with a corporation.
  • Ownership of a corporation is easily transferable.
  • Capital can be raised more easily through the sale of stock.
  • A corporation possesses centralized management.

Disadvantages:

  • Governmental regulations, possibility of double taxation, must maintain corporate formalities such as annual meetings and other resolutions.

Limited Liablity Companies (LLC’s)

The limited liability company or LLC is not a partnership or a corporation. An LLC is a distinct type of business that offers an alternative to partnerships and corporations, by combining the corporate advantages of limited liability with the partnership advantage of pass-through taxation.

Advantages:

Pass-Through Taxation. LLCs allow for pass-through taxation. This means that earnings of an LLC are taxed only once. The earnings of an LLC are treated like the earnings from a partnership, sole proprietorships and most S corporations.

Limited Liability. The LLC owner’s liability is generally limited to the amount of money which the person has invested in the LLC. Thus, LLC members are offered the same limited liability protection as a corporation’s shareholders.

Flexible Management Structure and Flexible Ownership is Permitted. Like general partnerships, LLCs are generally free to establish any organizational structure agreed on by the members. Thus, profit interests may be separated from voting interests.

Disadvantages:

  • More Paperwork Than an Ordinary Partnership. Documents must be filed at the state level to create an LLC, which is not the case with a general partnership.
  • Dissolution Date. Some states require that a dissolution date be listed in the articles of organization. This date may be amended. Further, certain events, such as death of a member, a member leaving, bankruptcy, etc. can be a dissolution event. A corporation has unlimited life and these events are not dissolution events for a corporation.
  • Newer Entity Type. The LLC is a newer entity, and people are not as familiar with the LLC as a corporation.

We can assist you with the formation of these entities. Please contact us so that you and your business are protected.

This entry was posted in Article - Law Library, Business & Corporate Law, Practice Area. Bookmark the permalink.

Comments are closed.