Which "Entity" is Right For You?
To most people, liability is usually a secondary consideration. Your choice of corporation, “S” or “C”, Sole Proprietorship, Partnership or Limited Liability Company affects your taxation and the liability that flows through to your personal property.
The option of incorporating or forming a company provides several benefits and disadvantages. This is why an Asset Protection Plan is crafted to suit your personal situation considering your business risk, your family estate plans, your personal assets and the weight of your tax burden.
Take for example the difference between an S Corp and a Limited Liability Company for “write offs.” In an S Corp a principle does not have the taxation on health care and in aLimited Liability Company the membership must declare the health benefits as income. If a stockholder is sued in an S Corp, the suit can flow through to that person’s personal assets; making an S Corp known as a “pass thorough” entity. In a Limited Liability Company, it is much easier to keep the liability to a “limit” and protect the members.
The big question is “which entity” is the right one for you? Although it is important to make a detailed examination, here is some insight. One of your first decisions is to decide how your business should be structured.
Sole Proprietorship – This structure is simple because you only have to deal with one proprietor (you) and this structure has the least amount of rules and regulations. This business does not exist outside the owner of the business and all of the owner’s business and personal assets are at risk. The only advantage to this business is the total freedom for the owner to do what they want as long as they follow taxation regulations and the laws.
Partnership – A Partnership is a business relationship between two or more people. A Partnership is a legal agreement (not just a handshake) regarding the control that one partner has over another. Each person is subject to the unlimited liabilities of the other. This is an even greater risk than a Sole Proprietorship because one partner is liable not only for himself, but for the others. The profits from a “Partnership” may be distributed to the partners without any “double” taxation.
Corporations – “C” Corps and “S” Corps
A corporation is a designation of law and is referred to as “S” or “C” by the location in the U.S. Tax Codes.
“C” Corp – This Corporation has very strict organizational rules for Shareholders, Directors and Officers. The distributions of the profits are taxed “twice”, once on the corporate level and the second time at personal distribution. One of the major advantages is the limited liability of the founders, and investors are generally limited to the amount of the initial investment of contribution.
“S” Corp – An “S” Corp must have no more than 100 Shareholders. In an “S” Corp the income, losses and deductions generated by the corporation can be “passed through” the corporate entity to the individual Shareholders. Therefore, there is no “double” taxation. In addition, Shareholders of this entity can personally deduct any corporate losses. The liability is similar to the “C” Corp.
Limited Liability Companies – This is the hybrid structure of business. Limited Liability Companies, LLC’s, are subject to many of the liabilities of Partnerships and this is why an ironclad Operating Agreement is important.
There are times when “ironclad” isn’t ironclad to the court system. Law has become a science of predicting circumstances, and liability is an easy subject when any debt is secured in court. Although this entity provides protection and tax benefits, don’t be fooled into thinking it is fail safe.
One thing that you should understand about liability is that it is not a clear right and wrong issue or a black and white issue. One partner can be held 25% responsible for the other or 100% responsible for the other depending on how the courts rule with regard to responsibility. Circumstances do matter, what is in writing does carry weight and damages can occur outside of our awareness, making us liable and putting our possessions at risk.
The entity you choose is a business decision between security and prosperity. There must be a balance to achieve success.