Choosing the right business entity is an essential step for all business owners. Whether growing the business or starting a new venture, understanding your choices regarding how to legally form your business can help owners find suitable options for them. A business’s structure has many ramifications, including legal, tax, and financial liabilities. If you need to understand the best entity for your business, schedule a consultation with the experienced business attorneys at Harrison Law, PLLC, by calling (480) 320-2310.
Why Is It Important to Choose the Right Business Entity?
According to the Internal Revenue Service, businesses must decide on the type of entity to establish. This governmental classification can help regulate certain parts of the company. The entity will determine the tax burden on the federal side, while it can have liability ramifications on the state level. Choosing the proper business structure could be one of the most crucial decisions an owner can make.
How Do I Choose a Business Entity?
Choosing the right business entity depends on how the business wants to manage personal liability, minimize taxes, access financing terms, and set expectations for its operation. Business structures have specific advantages and disadvantages. Owners should base decisions on their particular situation. There is no one-size-fits-all option. All business owners need to weigh the benefits of each classification before selecting an entity.
Business owners need to choose carefully. According to the United States Small Business Association, these decisions will affect the business in the future. While a company can convert to another entity, it can lead to involuntary dissolution and tax consequences. When you consult with a business law attorney at Harrison Law, PLLC, you may have a better understanding to choose the right option.
Types of Business Entities
Fortunately, business owners have many options for their business entities. There are several types of legal structures. These options include:
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Sole Proprietorship
The sole proprietorship is one of the most common and straightforward legal business entities. This structure allows the sole business owner to control all business operations. However, the owner is fully responsible for debts, liabilities, and financial obligations. Sole proprietorships are uncomplicated legal entities compared to others. The sole business owners can report all losses and profits on an individual tax return. The company is considered a sole proprietorship when a business has a single owner. Full responsibility means total legal liability. Any outstanding financial obligations, losses, and debts mean the owner will be responsible for those liabilities. Also, there could be fewer funding sources for sole proprietorships.
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Partnership
A partnership is similar to a sole proprietorship, but two or more parties own a piece of the business. All partners will share losses, profits, and operational duties. Partnerships are available in two different types: limited or general partnerships. In a limited partnership, some owners may act as “silent partners” in the business. With a general partnership, all parties have taken an interest in business operations. In a partnership, all losses and profits will “pass through” to the individual partners, allowing them to be recorded on personal income tax forms. Like a sole proprietorship, every partner is responsible for financial obligations. For example, a general partner can be held liable or sued for another partner’s actions.
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Corporation
A corporation is considered a separate legal entity, with structures governed by the state laws where the owners incorporated the business. Corporations can include shareholders, owners, boards of directors, and various officers. A corporation often has many roles, with one person in charge of all these individuals. Since corporations are separate legal entities, stockholders have limited liabilities, meaning investors are not responsible for debts or losses beyond invested amounts. Along with that, corporations have a few tax advantages as well. However, incorporating can be expensive, and the income can be taxed twice: when earned and distributed to stockholders. S-corporation may be able to alleviate some of those problems.
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Limited Liability Company (LLC)
Those who want to combine the benefits of a partnership and corporate structure may choose a limited liability company. These business structures allow owners to manage profits and losses with limited legal liabilities. LLCs offer a flexible approach to tax designation. With limited liability, the Internal Revenue Service will enable owners to choose whether they want to be taxed as a “pass through” or separate entity. Individual equity holders can incur losses from debt or benefits from profits. Like other business structures, LLCs protect owners from any personal legal liability. Limited liability companies may have issues attracting venture capital, requiring them to convert to a corporate structure.
What Are the Five Most Important Factors To Consider When Choosing an Entity Type?
Several factors should come into play when considering a business entity. Some of the most important factors include:
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Raising Capital
When a business owner needs to raise capital for growth or expansion, the type of business entity influences the regulation of borrowing money and ease of finding lenders.
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Tax Treatment
Many business owners want to avoid double taxation. For that reason, these owners choose an entity with the least amount of tax. Some entities may be taxed twice.
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Liability Protection
Keeping the owner’s personal assets protected from debts and lawsuits is one of the most critical considerations for forming a business entity. Many of these structures can protect the owner from legal liabilities.
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Transferring Ownership
Working with several partners may lead to problems, especially when it comes time to transfer ownership. Some entities allow an easy transfer conversion, while others require the partnership to be dissolved and sold.
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Ease of Formation
A few business entities are costly and difficult to form. A sole proprietorship is one of the most uncomplicated entities to establish. However, many others require paperwork and must meet specific regulatory issues.
Talk To an Experienced Arizona Business Law Attorney Today
Choosing the right business entity can be complex. These decisions can affect the owner’s tax and legal liabilities. While owners may convert different structures in the future, it can lead to significant problems for all parties. All business entities have their own pros and cons. When you schedule an appointment with a business law attorney at Harrison Law, PLLC, you could have your questions answered concerning these structures. Schedule an appointment by calling (480) 320-2310.
© 2022 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved
This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.
