Many small businesses start out as sole proprietorships or partnerships, usually because they’re the simplest to get up and running.
For most businesses, though, the small amount of extra time and expense involved in setting up a corporation or limited liability company (LLC) will be well worth it.
The most important benefit of doing business as a corporation or LLC is that these entities have limited liability.
With a few exceptions, the owners of an LLC or corporation are not personally liable for the company’s debts.
Two major exceptions are that you’ll remain responsible for your own wrongful acts and omissions, and you’ll be responsible for any debts you’ve personally guaranteed.
Your personal assets, however, will usually not be at risk for the acts or omissions of your employees and co-owners or for company obligations when you contract only in the name of the business entity and comply with all of the formalities required for these entities.
Your personal assets are at risk if you’re doing business as a sole proprietor or partnership. This means it’s almost always best for you to do business as a corporation or LLC if you have employees or partners.
Even if you don’t, if you’re able to contract with suppliers and the like only on behalf of the business entity, then those parties will be able to recover only from the business entity when contract problems arise.
Another benefit is that LLCs and corporations have what is known as perpetual existence. That is, they continue to exist even if their ownership or management changes.
There may be some tax benefits to doing business as an LLC or corporation as well, if the business is structured properly.
Now that you know why you should do business as an LLC or corporation, the next step is choosing the business structure that will best protect your assets as well as provide the most tax benefits in your particular situation.
LLCs tend to be the most flexible structure, since they can elect to be taxed as a C corporation, S corporation, or partnership (or, if there’s only one member, as a “disregarded entity” or sole proprietorship).
In addition, LLC owners typically have more flexibility in how and by whom the business will be managed as well as in how profits and losses will be distributed. LLCs can also have two classes of ownership, which could be beneficial if used for estate planning purposes.
LLCs also tend to be simpler to maintain and have fewer formal recordkeeping requirements.
On the other hand, corporations can offer more flexibility in structuring arrangements with third parties and offering ownership in the company to employees.
S corporations allow for pass-through taxation, but have a limit of 100 shareholders and cannot have more than one class of stock. Further, there are strict limits on who can be shareholders.
A downside of operating as a C corporation is double taxation. C corporations pay tax on their profits, and the shareholders are taxed on the dividends they receive. If you plan to have the business go public or to seek funding from investors, however, it’s usually best to structure your business as a C corporation.
C corporations also offer additional flexibility over S corporations for estate planning purposes, since a second class of stock can be used to convey an ownership interest without control.
There are numerous other factors to consider when choosing a structure for your company. In addition, there are other devices which can be used to help you protect assets and achieve tax benefits.
Please feel free to contact us if you need any help deciding how to structure your business or with setting up a new business.
Photo by Scott Graham on Unsplash
