We know there are a lot of choices and it can be very confusing on what type of entity to pick for your small business. If you talk to five people they will probably give you five different answers. There is no one right way to go but here is an overview of your options and a strategy at the end of the article on how to decide. Keep in mind a lot of this article was written by a lawyer and modified very little for ease of reading.
Small business owners may consider various possibilities when selecting a legal structure for his or her new business. The list of possible structures includes (a) proprietorships, (b) co-partnerships (or P/Ss), (c) limited partnerships (or LPs), (d) traditional corporations (or C-Corps), (e) corporations qualifying for special tax treatment under Subchapter S of the tax code (or S-Corps), and (f) limited liability companies (or LLCs).
Back in the day, most entrepreneurs set up their firms as proprietorships, S-Corps, C-Corps, LPs or P/Ss. Nowadays, though, many of your colleagues opt to establish an LLC. Those colleagues consider the LLC structure the preferred model to maximize (to the extent legally possible) managerial discretion, economic flexibility, creditor protection, tax efficiency, procedural convenience, filing simplicity and liability insulation. To consider a few particulars:
• An LLC permits the perpetual existence of the entity, notwithstanding the disaffiliation of a member (unlike the case of a proprietorship, a P/S or, in some cases, an LP).
• An LLC readily permits the establishment of managerial authority that the founder may customize to accommodate the particulars of the entity and its participants (unlike the case of a proprietorship, a P/S, an LP, a C-Corp or an S-Corp).
• An LLC permits the creation of economic rights and priorities customized to accommodate the particulars of the entity and its participants (unlike the case of a proprietorship or an S-Corp).
• An LLC permits multiple equity holders (unlike the case of a proprietorship).
• An LLC places no restriction on the nationality, type or number of equity holders (unlike the case of an S-Corp).
• An LLC provides its equity holders (qua equity holder) with insulation against the liabilities of the entity (unlike the case of a proprietorship, a P/S or, in some cases, an LP).
• When dealing with the legal formalities of the entity, an LLC ordinarily requires less periodic documentation than an S-Corp or a C-Corp.
• An LLC allows only a single tier of tax, with all federal-tax attributes assessed directly against the equity holders and none against the entity itself (unlike the case of a C-Corp).
• In the case of an entity relying on substantial funds from lenders, an unprofitable LLC will often allow the equity holders to reduce their personal income taxes to a more-generous degree than in the case of an equally unprofitable S-Corp (even though an S-Corp also generally allows for the pass-through of tax attributes directly to the equity holders).
• If the equity holders of an LLC were to liquidate the entity, that transaction would ordinarily generate less income tax than if the liquidating entity were a C-Corp or S-Corp (even though an S-Corp also generally allows for the pass-through of tax attributes directly to the equity holders).
• Contributions by an equity holder to the capital of an LLC (even when contributing a tangible asset) face fewer tax-related hurdles than a contribution to the capital of a C-Corp or an S-Corp.
• In-kind distributions by an entity to an equity holder ordinarily qualify for tax-deferred treatment in the case of an LLC (unlike the case of an S-Corp or a C-Corp).
Keep in mind, though, that no legal structure can perfectly accommodate your individual needs and that another structure (such as the S-Corp) might better suit you. Also remember that no structure can eliminate every disagreeable facet of commercial operations, whether from the standpoint of (i) taxation (since the IRS will inevitably assess you, and possibly also your firm), (ii) liability insulation (since you yourself will ordinarily incur liability for negligence that you personally commit), or (iii) other adversity.
Whatever structure you select, you will need to observe the formalities (and you will also need to maintain the dedicated books and records) designed to legally separate you from your firm. This effort will also entail at least one set of organizational filings (and at least one set of initial tax filings) with your state of residence. The IRS will also expect at least one set of initial filings. Ongoing compliance measures (whether cast as internal actions or as filings) will apply throughout the life of your new firm.
All that legalese being said, we are hearing that a lot of small business owners are going with an LLC type structure for their new companies.
No one should think of the foregoing discussion as individualized recommendations or as legal advice. Accordingly, we strongly suggest that you consult with your own lawyer before selecting a structure.
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