Which Type of Business Entity Is Best for My Business?
Americans have long been known for their entrepreneurial spirit. If you are an entrepreneur who is planning to start a small business, you will need to make a number of important decisions before the business officially opens its doors. One of those decisions is which type of legal structure is best for your business. The Irvine business litigation lawyers at Brown and Charbonneau explain the most common business entities available and offer some factors to consider when making your decision.
Traditional Business Entity Types
There are three basic types of business entities for a business: sole proprietorship; partnership; or corporation. If you operate a business and fail to indicate which type of legal structure your business will utilize, your business will be treated as a sole proprietorship by default. A number of alternative and hybrid structures have also evolved from the traditional corporation (C-Corp), such as an S-corporation (S-Corp) and an LLC. There are advantages and disadvantages to every type of business structure that should be considered prior to deciding which type of entity is right for your business.
A sole proprietorship is simply an individual operating a business. There are no legal documents required to form a sole proprietorship nor must you file a separate tax return for your business if it is a sole proprietorship. You can request an Employer Identification Number (EIN) from the Internal Revenue Service (IRS) if you wish to use one for your sole proprietorship; however, you are not required to do so. If you choose this type of business entity, all profits and losses of the business will be claimed on your own personal tax return. While a sole proprietorship is extremely simple to create and operate, it is less attractive to potential investors and it leaves you open to personal liability for debts and liabilities of the company.
A partnership is two or more people operating a business and sharing in the profits. In a General Partnership, two or more people contribute equally to the business and agree to share equally in the profits, losses, and management of the business. You are not legally required to create any legal documents in order to create a partnership; however, most partnerships do choose to enter into a written partnership agreement. A Limited Partnership must have at least one general partner and at least one limited partner. The general partners are responsible for the day to day operation of the business and share fully in the profits and losses. Limited partners share in the profits of the business; however, their losses are limited to the extent of their investment in the business. Typically, a limited partner has little, or no, authority with regard to the operation and management of the business. Some states require you to file documents with the Secretary of State if you elect to operate a Limited Partnership. A partnership enjoys “pass-through” taxation, meaning that the profits and losses of the business are “passed through” the business to the partners. A partnership does file a tax return but the profits and losses are claimed on the partners’ individual tax returns. As a partner, you are personally liable for the debts and liabilities of the business even though each partner often has the authority to make unilateral decisions for the business.
Traditional Corporation (C-Corp)
A corporation is considerably more difficult to create and more complex to operate. A number of legal documents must be created and filed to form a corporation and a corporation is treated as a separate legal entity for tax purposes. A corporation must file a separate tax return, resulting in “double taxation.” Both the corporation and the shareholders (owners) pay taxes on the profits. On the plus side, you avoid personal liability for the debts and liabilities of a corporation and corporations are usually more attractive to banks and investors.
An S-Corp is an offshoot of a traditional corporation wherein profits and losses are passed through directly to the owner’s personal income without being subject to corporate tax rates. You still get the benefits of liability avoidance without the double taxation of a traditional corporation. There are, however, down disadvantages to forming an S-Corp. The type and number of shareholders are limited with an S-Corp, effectively limiting future growth and investment.
Limited Liability Company (LLC)
This type of business entity offers much of the same liability protection as a traditional corporation without all the formalities and without subjecting the owners to pass through taxation. In addition, unlike the shareholders of an S-Corp, the “members” of an LLC are not limited by type nor number. Like a traditional corporation, there is a considerable amount of work required to form an LLC; however, once it is up and running it is easier to maintain than a traditional corporation.
Contact Irvine Business Litigation Lawyers
If you have additional questions or concerns about the various business entity options for your business, it is in your best interest to consult with the experienced Irvine business litigation lawyers at Brown & Charbonneau as soon as possible. Contact the team today by calling 714-406-4397 to schedule your appointment.