What Type of Entity Should I Form?
Trying to find out which legal structure will best suit your business can be challenging. The decision you make will determine how much you have to pay in taxes, the way you do your paperwork, and most importantly, your personal liability. This is one of the most frequently asked questions by our clients – and there is no quick, easy answer!
Here is an overview of the basic options. But before you decide which structure is right for you, consult with a specialist – a CPA or business attorney – so that you get advice that is specific to your business.
Four types of business entities
The most common business entities are sole proprietorship, partnership, corporation, and limited liability company. You will see that each varies with respect to taxation, liability, and record keeping.
A sole proprietorship is the most common form of business organization and very easy to start. One person owns and manages a sole proprietorship, which also means this owner is responsible for all debts and financial obligations incurred.
All that is required to get started is a social security number and a DBA (if you are not using your name as the business name).
In a partnership, two or more people agree to share the responsibilities and profits/losses of a business. Each partner is personally liable for the financial obligations of the business.
In addition to a standard partnership there is also a Limited Liability Partnership (LLP). In an LLP, one partner is not responsible or liable for another partner’s misconduct or negligence.
Many potential partners come into our office and put a huge focus on drafting a perfect written partnership agreement that addresses every potential issue that they may encounter during the life of the partnership. In our experience, the only time a partnership agreement is referred to is when everything is falling apart at which point the partners throw the original agreement in the garbage and figure out what they need to do next to either resolve the business problem or dissolve the partnership!
A business partnership is similar to a marriage – if you need a big long written agreement up front then you probably shouldn’t be getting married
Shareholders own a corporation (also know as a C Corp), but the corporation itself is liable for its taxes, debts and actions – separate from those who founded it. A corporation has more complex legal and tax requirements which we would be happy to outline for you.
The key advantage of forming a C corporation is the ability to issue multiple classes to stock – a good option for companies looking to raise investment money with a complex capital structure (Class A, Class B, Preferred Shares, etc.)
An S Corporation (S Corp) is a slightly different corporate structure created through an IRS tax election. The primary benefit of this structure is that it allows a business to avoid double taxation – once to the corporation itself and again to the shareholders. There are a number of requirements to qualify for S Corp status. Contact us and we will be happy let you know if your business qualifies.
Limited Liability Company (LLC)
This “hybrid” entity combines aspects of a corporation and a partnership. Owners of an LLC are called members. Similar to an S Corp, profits and losses are passed through to owners without taxation of the business itself. Owners are also shielded from personal liability.
|Owner has complete control||Shared financial commitment||Personal assets protected||Self-employment taxes
|Income goes to owner||Shared profits||Capital through stock sales||Restrictions on profit-sharing
|>> Unlimited liability||>>Joint and individual liability||>>Limited liability||>>Limited liability|
Which structure makes the most sense for your business?
You should assess the entity types based on your individual situation, finances, commitment, and resources. Also take a look at long-term goals and future needs for your business.
Don’t take this very important decision lightly, and don’t make a choice without sound advice from business experts.
Contact Sousa & Weber to discuss and review the pros and cons of your options. We are very well versed in business formation and will highlight the benefits and challenges of each business model.
Sousa & Weber, LLP is a Los Angeles accounting, tax, and business advisory firm providing services to a wider range of small businesses, private companies, and individual clients. 877 317-4047