There’s not one business entity form that is best for all situations. The choice depends on several factors, the most important of which include your need for limited liability, your tax situation, how you want to manage your company, and the amount of paperwork you’re prepared to tolerate. You also have to consider the laws of the state – which can vary significantly - in which you organize.
Limited Liability. Corporations and limited liability companies offer limited liability to the owners. Limited liability means that creditors – including people who sue you – can only reach the assets of the business. Owners of solo proprietorships and general partnerships do not have limited liability. They have unlimited personal liability. That means creditors can reach the personal assets of the owners.
Complexity and Expense. The sole proprietorship is the simplest form. Corporations have the most administrative formalities including adopting bylaws, electing officers and directors, and holding annual meetings. If you fail to comply with those formalities, you risk losing your limited liability and giving creditors access to the personal assets of the owners. The concept is called piercing the corporate veil or setting aside limited liability.
Management and Ownership Structure. Your sources of funding and your need to accommodate changes in ownership and accommodate owners who will not actively participate in management will all impact your selection of a business entity form. For example, if you hope to get venture capital financing, venture capitalists tend to be more comfortable with the corporate structure.
Taxation Issues. Corporations are double-taxed. That means the corporation itself files a tax return and pays tax. When the corporation distributes money to its shareholders, the shareholders pay tax on those distributions. Partnerships have pass-through taxation meaning that instead of the partnership itself filing a tax return, the individual partners report the earnings and losses of the partnership directly on their personal income tax returns.
Ten years ago, business owners had to choose between the pass-through taxation of partnerships and the limited liability of corporations. With the introduction of entity forms like the LLC, business owners can have both.
Comments