Business Entity Selection
If you own or manage a business, you should consider usable, effective documents to help you conduct your business in a safe and professional manner. You should consider the “exit strategy” for what happens to the business interests if you become ill or pass on. McManus Estate Planning LLC has broad experience in writing and reviewing business agreements.
An important consideration if you are starting a business is Business Entity Selection. You will need to choose an appropriate legal business entity. Each of the several options has a specific structure and features—and each type has different laws governing its formation and operation. Choosing a business entity is a critical step in providing you with both potential tax advantages and legal protection of your assets.
There are many choices of business structure, including but not limited to
- Sole Proprietorship
- General Partnership
- Limited Liability Company (LLC), including Single-Member LLC
- Limited Partnership
- Corporation (C Corporation or S Corporation)
Sole Proprietorship is a common business entity, but one that incurs some risk for its owner. The individual owns all of the business’s assets and has unlimited personal responsibility for all of its liabilities. This type of business provides no intrinsic legal protection of personal assets. A sole proprietorship may be owned by only one person, who is personally responsible for the taxes on all income for the business at applicable tax rates. We generally advise against sole proprietorships because of the potential for personal liability.
Two or more people operating a business together can form a General Partnership. Each general partner participates in the operation and owns assets and shares of the profits or losses. If there is no agreement to the contrary, it is assumed that general partners always own equal shares of the business, even if they contribute different amounts of capital and labor into the business. Each partner bears personal responsibility for the business, including tax liabilities, which are taxed through each individual’s return. While a partnership agreement may delineate specifics the relationships among the partners, no partner has protection against issues raised by missteps of one of the partners. A lawsuit against the business because of one partner affects all partners equally—and can extend to their personal assets. Because legal protection is so limited and all of the partners’ assets are potentially at risk, we generally recommend that our clients not join general partnerships. All of the other business entity options offer some liability protection.
A Limited Liability Company, which must file articles with the state, combines elements of both partnerships and corporations. In an LLC, the owners are known as members, and they risk losing only the money that has been invested into the LLC. An LLC is not a separate taxable entity, and its members must report business income or loss on their personal income tax returns, as if they were in a partnership. They benefit from the same sort of protection from personal liability as corporations, hence the term “limited liability.” Only the LLC assets are at risk in the event of a lawsuit or company debt. This protection can evaporate, however, if the LLC owners take actions that are deemed illegal, unethical, or irresponsible.
For a solo operator, a Single-Member LLC is a viable alternative to the sole proprietorship, which offers no liability-limiting protections. When there will be one or more limited partners—contributing capital and sharing in profits, but not active in management—a Limited Partnership provides an excellent solution with asset protection. For the limited partner(s), asset liability is proportional to the size of the initial investment of capital. When all owners perform management duties, a limited partnership is not a viable option because it would jeopardize their status as limited partners.
A Corporation is a separate legal and taxable entity. Statutory formalities govern the setting up of a corporation. Except under certain circumstances, the owners of the corporation are personally protected from the corporation’s liabilities. When capitalizing a business with outside investment, it is important to make clear whether or not investors will be able to vote when issuing ownership interests—essentially private stock—and to determine whether investment returns will take the form of equity growth or income distributions.
Sometimes a business owner will change the type of business entity in order to change the ownership of the business. An owner might, for example, wish to transfer ownership by using gifts, installment sales, stock redemptions, a bequest, or a combination of two or more.
Each business entity selection is unique. At McManus Estate Planning LLC we acquaint ourselves with all aspects of your business so we can carefully match the benefits of the various entities with your objectives. We will help you consider all of the alternatives and help you make the best choice. Contact our offices to explore your business entity options and to write or review the contracts you plan to use.