3 Tips for Choosing a Business Entity
Entrepreneurs face formative decisions daily, but one decision in particular has serious implications for the future: choosing a legal structure, also known as a business entity.
This decision determines a number of hard-hitting realities, including how much you’ll pay in taxes, the administrative and record-keeping burden, your personal liability, and the legal specifics for getting money into the business. Even more, some entity selections are difficult to change once you’re locked in, with tax and legal implications that can make switching costly or difficult.
Sole proprietorship? Corporation? LLC? The sheer number of intricacies between one entity and the next explains why some entrepreneurs choose hastily, vowing to give it more thought down the road. If that scenario sounds familiar (or tempting), consider this:
All of this can sound daunting, but here’s the silver lining: It doesn’t have to be. Tools and resources exist to help you understand and choose the best entity for your enterprise. Here are three steps you can take to choose the right legal structure for your business.
1. Familiarize yourself with the basics
No one expects you to know the ins and outs of an LLC versus a Partnership, but learning the fundamentals can help decision-making. The U.S. Small Business Administration website offers a helpful grid outlining the differences between each business structure.
A sole proprietorshipis a business with one owner. Sole proprietorships are the most common business entity. They’re also the easiest and most inexpensive to set up, as no legal documents are needed. The flip side of this simplicity? Sole proprietorship owners can be held personally liable for any debts or legal liabilities.
Partnershipsare business entities with two or more owners. A partnership is not taxed as its own entity; rather, partners split the tax burdens on their individual income tax returns. In this regard, some partnerships resemble sole proprietorships simply owned by more than one person. Like sole proprietorships, a key drawback here is liability, which was a driving force behind the creation of partnership variations: general partnerships, limited partnerships, and limited liability partnerships. These variations alleviate some risk, albeit in highly specific ways.
Corporationsare legal entities owned by shareholders, managed by a board of directors, and operated by officers. They shift personal liability from business owners to the business itself. Corporations require more documentation than partnerships, and therefore come with the greatest administrative burden. Whereas the extent of a partnership’s burden depends on how it’s structured, corporations are always required to have six things: Articles, bylaws, organized meetings, a board of directors, annual shareholder meetings, and recorded minutes. Like partnerships, corporations offer several variations. Businesses deterred by the double taxation inherent to corporations sometimes opt for subchapter corporations (“S corporations,” a take on popular C corporations), which, like partnerships, let principals handle taxation on their individual tax returns.
A limited liability company (LLC) is a hybrid type entity which combines certain characteristics of partnerships and sole proprietorships with those of corporations. Profits and losses are passed through to the owners (unless the owners chose to be taxed as a corporation), yet owners are also can be shielded from personal liability. Another LLC benefit, they are one of the most flexible entities and the way they are structured allows them to be changed more easily in the future if the owners needs and desires change.
2. Consult an accountant and a lawyer
The specific tax implications of different entities are best understood and explained by accountants. Additionally, resistthe urge to lock into a business entity without consulting a lawyer; entities are governed by state law and specifics vary from state to state. Business pros like Haefele Flanagan aren’t allowed to practice law, so while we’re in-tune with local law and can provide insights on this front, the final word is best left to legal pros.
3. Consult business experts
Haefele Flanagan fields questions, missteps, and confusion from business owners, underscoring the value we offer businesses as they take the critical step toward becoming a formalized entity.