How to Choose A Business Entity

4 Factors to Consider

When starting a business, you have to make a ton of decisions. Deciding what to name your company and hiring employees, what kind of products or services you should sell, and how to fund your operation, getting your business off the ground comes with a nearly endless number of decisions.

Of all these decisions, perhaps none is more important or has a more significant impact on your success (or failure) than your choice of business entity structure. Indeed, the entity you choose for your business will affect everything from the amount of taxes you pay and what kind of records you are required to keep to how vulnerable your assets are to lawsuits incurred by your company.

Which business entity should i choose?

Among the different business entities, all companies should be one of the following legal structures: a partnership, corporation, or limited liability company (LLC). While you should consult with us before making your final decision, here are four of the leading factors to consider when selecting the entity that’s best suited for your particular business.

1. Business Entity Ownership

The number of owners your business has will factor into the business entity forms that are available to you to choose from. For example, if you own the business yourself, you can operate as an LLC, or a corporation without any other partners. If you choose an LLC, its owners are called “members,” so you would operate as a single-member LLC. If you choose a corporation, the owners are “shareholders,” and you can be the sole shareholder of your corporation.

If your business has more than one owner, your choices of an entity include a partnership, an LLC, or a corporation. If you have multiple owners as an LLC, your company would be considered a multi-member LLC. Note: if your business has multiple owners, you MUST have a lawyer prepare your operating agreement or bylaws. Do NOT use a document service. Navigating ownership terms, transfer rights, what happens when a partner or shareholder wants out, and what happens at death all require consideration and custom decisions that cannot be addressed with a one-size fits all solution. If you do not have your multi-person business agreements documented by a lawyer you risk massively expensive surprises down the road when you go to sell the business; or when one of your owners dies or wants to get out of the business; or, when the business needs additional capital. So whatever entity type you choose, if you have a multi-owner structure, contact us to get your agreements in place.

2. Asset Protection

The second factor in your entity choice is protecting yourself from legal liability. In today’s highly litigious society, all businesses should prepare for legal conflict at some point. At minimum, that conflict could be as simple as a refund request, or as complex as an employee or team member lawsuit, or worse. If  you don’t have the proper entity in place, you could lose your home, your vehicle, and even your life savings to satisfy a judgment.

The same thing could happen if your company ever suffers a significant financial loss or goes out of business. Your company’s creditors could seize your personal assets to satisfy your business debt. This risk arises because unless you have the correct entity in place, there’s no separation between your business and personal assets, so your personal assets would be up for grabs in the event your company ever gets sued or goes into serious debt.

For example, suppose your company is a sole proprietorship or a partnership. In that case, you and the other owners are legally inseparable from your business—your business and its owners are the same in the eyes of the law. Therefore, you and the other owners would be personally liable for any debt or court judgment incurred by your company.

However, if you set up our business as either an LLC or a corporation, you can shield your personal assets from your company’s legal liabilities, including lawsuits and debt. When correctly set up and maintained, these two structures establish your company as a separate business entity that’s distinct from you and the other owners as individuals, preventing you from being held personally liable for the company’s debt or legal disputes.

At Artisan Law, we can help you choose the correct entity for your business and we an also support you in setting up and maintaining your entity to ensure you have maximum personal liability protection.

3. Which business entity is best for tax purposes?

Similar to your liability exposure, your entity selection also dictates how your business will be taxed. Suppose your business entity is a partnership. In that case, you and the other owners are legally the same as your business, so your share of the company’s profits or losses are reported on your income tax return and taxed at your personal income tax rate.

What business entity is subject to double taxation?

In contrast, as a C corporation, your business is considered a separate business entity from you and the other owners for both liability and business entity taxation purposes. As a result, the corporation pays taxes at the new flat corporate tax rate of 21% established by the Tax Cuts and Jobs Act (TCJA). Then, after-tax profits are distributed to the shareholders. Those profits are taxed at the personal rate of each of the shareholders. This rate, “double taxation,” means the corporation pays tax at its rate, and then the shareholders pay tax at their rates.

However, due to the expense and complexity of creating and maintaining a traditional corporation, very few small or mid-sized businesses are set up as C corporations. Yet you can still obtain the liability protection and tax advantages offered by a corporation by setting your business up as an LLC.

As an LLC, you have flexibility in choosing how you’ll be taxed. Unless you choose to be taxed as a corporation, a single-member LLC doesn’t pay any taxes on profits itself.  Instead, your profits are taxed on your personal tax return and you’ll pay taxes at your personal income rate.  This is called “pass-through” taxation.  In contrast, multi-member LLCs are taxed as partnerships. In such cases, your company doesn’t pay any taxes on its profits itself. Instead, your share of the net business income is also subject to pass-through taxation.

Alternatively, you can elect for your LLC to be taxed as an S corporation. In this case, you will be responsible for paying payroll, plus payroll taxes, and filing a tax return on behalf of the corporation.

The main advantage of choosing to be taxed as an S corporation is that you only pay payroll taxes on your payroll, not on your profit distributions from the company. In addition, there is some indication that the audit risk for S corporations is less than the audit risk for companies taxed as sole proprietors, where income and expenses are reported on your personal Schedule C.

Suppose your business is taxed as an S corporation. In that case, you will pay income taxes on your profit distributions. Still, you would save roughly 15% in payroll taxes on distributions taken as profits rather than as payroll. When using an LLC taxed as a partnership or sole proprietorship, you will pay payroll taxes on all distributions to you from the LLC up to the payroll tax limits.

However, for an S corporation election to make sense, you’ll want to have at least $75,000 of net income per year. To help you choose the entity that’s most advantageous in terms of taxation, meet with us or a Certified Public Accountant (CPA).

4. Administration & Operation

While partnerships don’t offer any liability protection, it is simple to set up and maintain. Suppose you start a new business and are the only owner. In that case, you are automatically a sole proprietorship in the eyes of the law, or a partnership, if you have more than one owner. There is no need to register your business with the state in either case, file any paperwork, pay any fees, and there are no special rules to follow.

While LLCs and corporations offer liability protection and tax advantages, those benefits come with specific administrative requirements known as corporate formalities. These formalities dictate how the entity must be structured, maintained, and managed. And suppose you fail to adhere to these formalities. In that case, a court could remove the protective barrier shielding your personal assets, known as “piercing the veil,” leaving you personally liable to creditors in the event of a judgment.

Corporations come with the most strict and complex administrative formalities. For example, you must file articles of incorporation with the state, hold a regular board of directors and shareholder meetings, create and enact corporate bylaws, and maintain detailed record-keeping requirements, such as keeping detailed meeting minutes. Additionally, you must also file annual reports with the state and pay yearly fees to maintain your corporate status.

LLCs also come with administrative formalities, but they aren’t nearly as burdensome as those for corporations. For example, as the owner of an LLC, you must file articles of organization with the state and create an operating agreement, which governs how your LLC is structured and run. In addition, all states require LLCs to file either an annual or semi-annual report with the state agency responsible for registering business organizations.

Although there’s no statutory requirement for LLCs to hold owner meetings or keep minutes, doing so provides strong evidence that you’re abiding by corporate formalities. Combining diligent record-keeping and clear separation of personal and business finances, you can offer your LLC extra asset protection from creditors.

Should you choose to set up as an LLC or corporation, at Artisan Law, we can offer support with maintaining your business records and the corporate formalities required. We offer exceptional maintenance packages to help ensure your entity meets these requirements and maintains the maximum level of protection for your assets.

Artisan Law Offers Guidance and Support

Properly selecting, setting up, and maintaining your business entity is far too important of a task for you to try to handle all on your own. We offer you trusted advice on the most advantageous entity for your particular business and then help ensure that your entity is properly set up. We can also provide you with sound business systems to make your business more efficient and establish a clear separation between your business and personal finances, which is a crucial part of maintaining your entity’s liability protection.

In addition, we will also ensure that you comply with the various state laws and administrative formalities required to maintain your entity and safeguard your assets, so you can remain focused on the most important task—growing your business. Contact us today to get started.

This article is a service of Artisan Law™ We offer a complete spectrum of legal services for businesses and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer a LIFT Start-Up Session™ or a LIFT Audit for an ongoing business, which includes a review of all the legal, financial, and tax systems you need for your business.