Forming Your Business – Selecting The Type of Entity

If you are considering forming a new company, there are several decisions to make about the form of business entity you choose. Whether you incorporate or simply become a sole proprietor, key areas to consider are the number of owners, potential liability, type of owners and tax treatment.

Number of Owners

A sole proprietorship, by definition, has a single owner – you. Corporations, however, may have many. ‘S’ Corporations can have 1 – 75 owners. Limited-liability Corporations (LLC’s) may have one or more. ‘C’ Corporations may also have one or more owners. Select the form of incorporation which gives you the most flexibility in ownership when combined with the tax treatment you desire.

Liability

One of the key benefits gained by incorporation is the limiting of the owners’ personal liability. Most corporate forms (and limited partnerships) reduce the owners’ exposure to liabilities, but being a sole proprietor does not limit your personal liability. Seek specific guidance in this area from your attorney, particularly professional corporations.

Type of Owners

Different types of business entities allow for different types of owners. All of them provide for individual owners or shareholders. ‘S’ Corporations allow for resident individuals and qualified Subchapter Trusts and no other entity. LLC’s and ‘C’ Corporations allow for any type of owner.

Tax Treatment

There are many variables and complexities in the tax treatment of the earnings from business entities. In general, earnings after expense either “flow through” to the owners’ individual tax returns or remain inside a corporate entity to be taxed at corporate rates. Flow-through entities include sole proprietorships, ‘S’ corporations and LLC’s whose earnings are reported on the owners’ individual tax returns (NOTE: some flow-through entities pay state income taxes). ‘C’ corporation earnings are taxed at corporate rates and can be distributed primarily as dividends – which in turn are taxed at the individual rate. Hence the phrase “double taxation.” SBW editors strongly advise that you seek guidance from a professional tax advisor.

Which Entity To Use

There are general guidelines which may be of assistance in steering you toward selecting a particular entity:

Sole proprietorships – small business owners who expect little or no net income after business expenses and who are unconcerned about liability issues.

‘S’ Corporations – individual business owners or partners who take a regular salary out of the business and wish to show remaining income as passive.

‘C’ Corporations – for those who plan on taking a company public or otherwise expect large number of individual shareholders or institutions.

LLC’s – due to the flexibility of ownership rules and the number of tax treatment options, those looking to form an LLC should strongly consider seeking professional advice.

Get Professional Advice

Don’t forget to ask your lawyer or accountant about what form of business entity makes the most sense for you. There are a number of items to consider and they will know what works best for you, your situation and your goals.