If you start or expand a business, you will need to determine what form of entity to use. The form selected can affect your control of the business, profits, taxes and liabilities. It is important to prepare a business plan and review these issues in detail with an attorney and financial advisor prior to forming your business entity.
The common forms of business entities are sole proprietorship (single owner); partnership (general or limited) corporation and Limited Liability Company. Below are some general pros and cons for each type of entity.
A Sole Proprietorship is the easiest and least costly type of business to start. The owner has absolute authority and doesn’t need to file a separate business tax return. The cons are the owner assumes unlimited personal liability for debts and ability to raise capital is limited. The owner’s death or illness may ruin the stability of the business.
A Partnership provides sources of capital, ideas, and skills. A partnership files an informational return but doesn’t pay taxes- each partner reports their share of income or loss on personal returns. The structure of a partnership is flexible. The downside is general partners have unlimited personal liability and it can be difficult to unwind a partnership should there be a dispute.
One of the good things with Corporations (except for professionals) the liability of shareholders is limited to the amount of their investment. Ownership is transferable and can be inherited and a corporation existence continues after death. This is the preferable entity for raising large amounts of capital. There are drawbacks including more paperwork and costs to set up and dismantle. The rules of governance are stricter than other business structures. A corporation must keep its own set of accounting records and file its own tax returns. Unless a Subchapter S Corporation, shareholders are subject to a form of double taxation.
A Limited Liability Company combines the tax advantages of a partnership with the liability protections of a corporation and the structure is flexible. However there is unsettled case law on the manager liability.
There are also issues related to taxes at all levels that need to be addressed with your financial advisor before deciding on a choice of entity. Finding the right form for your business structure will depend on the issues most important to you and your plan for operating the business.
John H. Prorok is a Partner with Maiello, Brungo & Maiello, LLP, practicing in the areas of real estate, corporate and business law. His experience in commercial litigation provides him with an invaluable understanding of clients’ needs in business planning, corporate formation and contract negotiations.