Business Formation

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Choice of Entity

One of the first decisions when starting a new business is choice of entity. There are several considerations including liability protection, tax treatment, flexibility, ease of formation and operation, and ability to raise capital.

Liability protection is a major factor in choosing a business entity. Limited liability means that the owners are protected from personal liability for the business’ debts and obligations. This means that the owners’ potential liability is limited to their investment in the business. Creditors of the business cannot come after the owners’ personal assets to satisfy the company’s debts.

Tax treatment is also an important factor. Some entities are treated as “pass-through” entities for tax purposes, meaning that the income of the business is treated as the income of the individual owners. The profits and losses of the business pass through to its owners, who report them on their personal tax returns. One benefit of pass-through tax treatment is avoiding double taxation.

Flexibility and ease of operation also differ between entities. Some entities require strict record-keeping requirements and other formalities such as annual meetings, while others have less burdensome requirements. Similarly, some entities have more stringent formation requirements than others.

There are numerous entity types to choose from when starting a business. The most commonly used entities include limited liability companies (LLCs), C-corporations, S-corporations, partnerships, and sole proprietorships. The basic characteristics of these entities are provided below:

Limited Liability Company (LLC)

Limited Liability? Yes
Tax Treatment: Pass-through
Flexibility/Ease of Operation: LLCs offer maximum flexibility with minimum formal operating requirements.
Ownership: Owners are called “Members”. Can have from one to unlimited members. May be owned by another business.

C-Corporation

Limited Liability? Yes
Tax Treatment: Taxed as separate entity; income subject to double taxation.
Flexibility/Ease of Operation: Corporations are less flexible with more formal operating requirements like annual meetings and recordkeeping requirements.
Ownership: Owners are called “Shareholders”. Can have from one to unlimited shareholders. May be owned by another business.

S-Corporation

Limited Liability? Yes
Tax Treatment: Pass-through
Flexibility/Ease of Operation: Corporations are less flexible with more formal operating requirements like annual meetings and recordkeeping requirements.
Ownership: Owners are called “Shareholders”. Can have from one to 100 shareholders. May not be owned by another business.

Partnership

Limited Liability? No
Tax Treatment: Pass-through
Flexibility/Ease of Operation: Partnership offer maximum flexibility with minimum formal operating requirements.
Ownership: Owners are called “Partners”. Can have from two to unlimited shareholders. May not be owned by another business.

Sole Proprietorship

Limited Liability? No
Tax Treatment: Pass-through
Flexibility/Ease of Operation: Sole proprietorships offer maximum flexibility with minimum formal operating requirements.
Ownership: Owner is called “Sole Proprietor”. Can have only one sole proprietor. May not be owned by another business.