Choice of Entity (Part I): Common Concerns and a Comparison

July 6, 2011
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It is a common recommendation for new business owners to think closely about the type of business entity that is most appropriate for their new enterprises.  The various business entities have different applicable rules and there is no one business form that is appropriate for everyone.

Major Concerns of Business Owners

When deciding on a business entity type, the main concerns that most business owners have concern:

  • Protection from liability;
  • Paying as little in taxes as possible;
  • Keeping control of the business; and
  • Ease of setup.

Most people who start a business are mainly concerned with the start-up costs, marketing, gaining business, setting up normal procedures, etc., and not about what happens in case of incapacity or a death.  This perspective is quite logical because most businesses start out having very little value or even have a negative value.

However, the longer the business stays afloat and the bigger the business becomes, there comes a point where ignoring the estate planning consequences of the selected entity can create very significant problems for the owner’s spouse and family if something tragic happens.  For example, what if anyone of the following is involved in the owner’s personal life:

  • The owner has no children interested in taking over the business;
  • Some of the owner’s children are interested in running the business and others are not;
  • The owner has a second spouse and children from the first marriage;
  • The owner’s children are “idiots”, and key employees don’t want to cater to them until they become smart;
  • Et cetera, et cetera, et cetera.

There are certainly effective strategies for each of these possibilities, but first, we must provide some basics.  The chart below covers the main characteristics of the most common business entities.  Immediately thereafter, we’ll further elaborate on a few of the terms used therein.

The Most Common Business Entities

ENTITYLiability TaxationControlFormality of Setup
SOLE PROPRIETORSHIPUnlimitedFlows through to ownerSole owner controlsEasiest
GENERAL PARTNERSHIPUnlimitedFlows through to ownersMainly in equal shares for each partnerEasy, but filing with state is usually recommended
LIMITED PARTNERSHIPUnlimited for general partner, and limited for limited partnerFlows through to ownersGeneral partner controls, regardless of percentage ownershipMust file with state, usually need formal partnership agreement to do so
C CORPORATIONLimitedDouble taxationMajority of shareholders controlMany specific requirements
S CORPORATIONLimitedFlows through to owner(s)Majority of shareholders controlSame as C Corp, plus organization must meet additional requirements to be able to elect S Corp status
LIMITED LIABILITY CORPORATIONLimitedFlows through to owner(s) unless elected otherwiseManager-members control, regardless of percentage ownershipMuch less than for C and S corporations

Further Clarifications of Chart Terms

 

Liability Column:

  • Limited:  Owners that have limited liability are only liable for business obligations up to the level of their individual investment.
  • Unlimited:  Owners with unlimited liability are also liable for all of the obligations of the business.

Taxation Column:

  • Flows Through to Owner(s):  Any profit or loss in the business is declared on the owners’ individual tax returns.  The entity itself owes no taxes.
  • Double Taxation:  The business profits are taxed at the corporate rate.  Then, any remaining income paid to owners (usually in the form of dividends) is taxed at their individual rates.
  • Flows Through Unless Elected Otherwise:  The LLC owners may choose how they are to be taxed.

Control Column:

  • Regardless of Percentage Ownership:  Control is based on the position held rather than how much of the business is owned.  For example, in limited partnerships, a general partner can own 1% of the business and still control it.
  • Majority of Shareholders Control:  When voting occurs, each share is voted.  The majority of the shares wins.  Owners holding a majority of the shares will automatically control the business.

In our next post, we will provide an example of a small business enterprise and give some rationale behind why it might select each of the six listed entities at various times.

 Choice of Entity (Part I): Common Concerns and a Comparison
 Choice of Entity (Part I): Common Concerns and a Comparison

Scott

Scott R. Zucker, Esq. is the owner of The Zucker Law Firm PLLC, located just outside the Capital Beltway in Annandale, within five miles of the City of Fairfax, the county seat of beautiful Fairfax County, Virginia. The firm focuses mainly on estate planning services for Virginia, Maryland and Pennsylvania clientele, and seeks to do so in an affordable and approachable way. People interested in learning more can contact Scott by phone or email.

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