Business owners are familiar with the need to analyze the risk-benefit ratio before moving forward with a transaction. An important part of this analysis is a full understanding of the components of the proposed transaction. Taking the step towards incorporating a business is not much different than moving forward with any other business transaction. The business owners need to become familiar with the different options for forms of business entities and weigh the risk-benefit of each to determine the best option for their interests.
Three questions that can help business owners begin this process include:
- How many owners are involved? Begin with this basic question. The answer can help to narrow down your options. Sole proprietorships or disregarded legal entities (for example a single member LLC), and sometimes a corporation can all work well for single owner entities, while businesses with more than one owner may want to consider a partnership, limited partnership, limited liability company (LLC) or corporation.
- What about liability protection? Different business entities offer different levels of liability protection. A business structured as a sole proprietorship offers less personal liability protection than an LLC or corporation. Sole proprietorships generally leave the owner’s personal assets at risk for financial obligations tied to the business. An LLC, LP or corporation structure results in a separate business entity. This can provide a shield between the owners’ personal assets and the assets of the business.
- How will the business handle taxes? Taxation is also different for different forms of entities. The tax attributes of sole proprietorships and disregarded entities generally flow through the business owner, because they are not viewed as separate entities by the IRS. The taxable income of C-corporations, in contrast, is subject to corporate income tax at the US federal level. In addition, distributions made by a C-corporation to its shareholders owners are also subject to tax. This is often referred to as double taxation. Partnership and S-corporations are commonly known as “pass-through” entities where the tax attributes generally flow through to owners for federal income tax purposes. These are high level simplifications and the distinctions between forms of entities need to be considered in the context of a particular business or investment.
These questions can help guide the initial formation discussion. It is important to note that these are just a few of the larger issues to consider during this discussion. Additional considerations include the forms of ownership and capital structure associated with each potential form of entity and the future needs of the business. An attorney experienced in these matters can help guide these discussions and better ensure that you choose an entity that meets your business needs.