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Business Entity Choices

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Biletsky Law - Start your businessDeciding which type of entity is right for your business can be a tough decision. There are many factors to take into consideration such as costs, taxes, liability, and legal fees. With the different choices that are available to you, it can sometimes be daunting to try to figure out which entity type is ideal for your business.

But don’t worry, you’re not alone. While entity specifics do vary from state to state, there are general similarities and differences between the states. This article will provide you with a brief description of some of the different entity types that are available to you. Although this article will give you a breakdown of the common characteristics of each type of entity, it is always best to consult a business or corporate attorney to help you decide on the best entity type to choose.

Sole Proprietorship

Regardless of the reasons that you may choose to go solo, a sole proprietorship is certainly the easiest business entity to set up in that you are the company. If you are operating your business using your last name, the process is even more simple. This is because you will only need to file a Doing Business As (DBA) of Ficticious Business Name with the county if you are using a name in which the owner is not easily identifiable. While the cost and ease of a sole proprietorship is alluring, one of the biggest downfalls is that there is no protection from personal liability. Since you are the company, there’s nothing to shield you from liability.

Partnership

A partnership can come in several different forms but the most common is a general partnership. One thing that you may not know is that although a partnership agreement is highly recommended, there does not need to be any kind of agreement between the parties for a partnership to exist. Rather, partnerships can be implied based on the actions of the parties (such as the sharing of profits and losses). General partnerships do not provide protection from liability for the partners, however there are several types of partnerships which do offer such protection. Without going into too much detail, there are limited partnerships where there is a general partner who is subject to liability and the rest of the limited partners who are shielded from liability. Depending on the state, there are also limited liability partnerships, and limited liability limited partnerships. The important aspect of each type of partnership is that there are two or more parties who are working together and either dividing profits, losses, or workload in such a way that a partnership can be implied.

Another aspect of a partnership is the manner of taxation. Partnerships have a “pass-through” taxation structure in that they are treated as disregarded entities and you will only be taxed once. This is in comparison to some forms of corporations where there is a double taxation, which will be discussed more in the corporation section below.

Limited Liability Companies

Recently, one of the most common entity choices are limited liability companies (LLCs). LLCs are attractive entity types because they offer the protection that a corporation offers, but also offers more flexibility in the structure of the company than what is possible to do with a corporation. LLCs are also unique in that you are able to elect how the LLC is taxed. This means that you can either be subject to double taxation, like a corporation (see below) or you can be taxed as a partnership or disregarded entity would be taxed.

Other forms of flexibility that an LLC has is the structure of the company itself. LLCs can be structured or managed in a variety of ways which helps the business be controlled in a customized manner that is best for the company.

Corporations

Corporations are generally divided into two different types of entities a C-corp and an S-corp (there are other types of corporations, such as a B-corp, but this article will focus on these general types). C-corps are generally used by larger corporations and do not have the certain limitations that an S-corp has. With an S-corp, you are limited to only 100 shareholders and can only have one class of stock. Whereas a C-corp does not have such restrictions. An S-corp further has some characteristics which are similar to LLCs. Such charecteristics include the option of being taxed as a partnership and therefore having single taxation. C-corps do not have the option of receiving pass-through taxation and are subject to double taxation. Double taxation means that those earning revenue from the corporation are taxed both at the corporate level and then at the personal level.

In addition to the taxation aspect, corporations are generally seen as the most favorable busines entity by investors and shareholders. One of the reasons for this is because of certain formalities that the corporation needs to follow in order for the corporation to retain its liability barrier.

There are many different charactersitics of each entity that is not discussed in this article and it is important to be aware of all of the nuisances of each before deciding on an entity. While the decision of which entity to form is certainly very important, choosing the wrong entity and figuring that out early enough can be a saving factor as many states allow conversions between entity types (for a fee).

For help with your business entity formation needs, contact Biletsky Law.

Where to Incorporate

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IMG_0464When the topic of what state to form your business in comes up, most people immediately say Delaware. In certain situations, this may be the right answer, but the state of Delaware is often thrown around as the answer more than it should. There are many issues to take into consideration when determining which state is the most ideal for your business to be formed in. We will go through a few of these important considerations below.

Where are you located?

Chances are it’s not in Delaware. Delaware certainly has its’ advantages when it comes to the cost of running a business as well as taxes, but it is often forgotten that you will also likely be subject to the fees and taxes of the state that you operate in. For example, a business that is incorporated in Delaware but that is doing business in California will likely need to register as a foreign company in California and will then likely be liable for California fees and taxes. However, Delaware does makes it easy for most small businesses in that if you are registered in Delaware, but are not doing business in Delaware, you will likely not need to pay any Delaware taxes (although certain fees may still apply).

What about the other states?

Delaware has long been held as the state that most people think of when it comes to where companies are from (especially corporations). There are many reasons for this, but one that sets it apart from the other states is called the “Court of Chancery”. Although it’s certainly a fancier name than your normal “Superior Courthouse”, this court’s main focus is business. Cases and controversies that go through this court enjoy expedited case times and are presided over by judges with particular experience in business issues. But at this point, this court is probably not what is convincing you to incorporate in Delaware.

Low and behold, other states saw Delaware’s success in attracting businesses with their low costs, no taxes, and discrete reporting and those states decided to jump on the bandwagon. The two other states who have made a name for themselves as the favorites amongst businesses are Nevada and Wyoming. These states offer similar low or no cost fees and don’t require certain reporting such as shares issued or who the directors are (this can be a big advantage when someone doesn’t want the world to know that they are the owners of the corporation for whichever reasons).

Nevada and Wyoming have even upped the ante with Delaware in that neither state instills any personal tax on a corporation owner and has no annual franchise tax. This is a substantial advantage in particular for other states which do have annual franchise taxes, such as California. California requires that an entity pay a minimum of $800 regardless of whether the company is even running or is operating at a loss. Having no such franchise tax in states such as Nevada and Wyoming is a great advantage unless you run into the issue that I mentioned above…where you still may be subject to the fees and taxes from the state you operate in.

So what does this all mean?

States such as Delaware, Nevada, and Wyoming have been designed as being very business friendly in the hopes of attracting your business to incorporate there. Often, many people will recommend one of these states as the state of incorporation. But the biggest issue that tends to be forgotten is that forming your company in another state does not necessarily leave you free and clear from having to pay the state that you operate in.

For more information on what state to incorporate in, contact Biletsky Law.