Meeting the goals of a new business: choice of business entity

The legal structure of a company impacts many aspects of the business.

In October 2015, former Federal Reserve Chairman Ben Bernanke wrote an editorial in The Wall Street Journal about where we are economically since the drastic monetary policies of his tenure were implemented during the “historic” financial crisis.

He lauded the current 5.1 percent unemployment rate that has improved faster than most economists predicted, as well as the low 1.5 percent inflation rate. He did, however, characterize economic growth as modest, noting that Fed policy cannot impact certain independent, important factors in a recovering economy, including the “energy and vision of entrepreneurs.”

No doubt, many entrepreneurs who have monitored the slow-but-steady economic improvement for the right time to kick off their ideas for new businesses will decide to do so now and in the near future.

One of the first and most crucial decisions they will have to make is choosing the right business entity in light of their goals.

The most commonly recognized business entities are the sole proprietorship, partnership, corporation and limited liability company, but other types are available. Entities are creations of state laws, so a new business owner should seek out an attorney who can provide legal advice about which entities are available in the state in question, as well as the particulars of state law that controls and impacts entity creation and ongoing business within that structure.

Another important piece of legal information needed to analyze entity choice is the role of federal and sometimes state or local tax consequences, specifically whether a business owner will be personally responsible for tax liability of the business (or able to report business losses on an individual return) or whether that liability attaches to the entity itself, in which case personal taxes would only be due on profits or salaries paid by the entity to the owner.

The basic features of the main business entities are:

  • A sole proprietorship is created when one person goes into business as the only owner. He or she does not have to create a legal entity to do so and is personally responsible for business debt and liability. Taxes are handled on the owner’s personal tax returns.
  • A partnership occurs if two or more people begin a business together. In most states, the partnership is automatically created just by going into business and the law presumes that the partners share equally in profits, personal tax liability and management power. Partnership liabilities are usually joint and several, meaning not only is a partner personally liable for his or her proportional share, but also for the entire amount. These assumptions can be altered by a partnership agreement.
  • The corporation is a separate fictional entity created by filing certain documents with the state. The corporation is taxed directly on business profits and absorbs losses and other liabilities separate from its owners, the shareholders. Shareholders are taxed personally when the corporation pays them dividends, sometimes called double taxation since the corporation has already paid taxes once on the business profits. Management is by an elected board of directors and appointed officers.
  • The limited liability company is a contemporary hybrid entity that combines positive aspects of other entities like shielding owners from personal liability while avoiding double taxation by allowing the owner-members to pay business taxes on their personal returns.

Representing entrepreneurs nationwide in matters of business formation are the attorneys of Zagrans Law Firm LLC with offices in Cleveland, New York, Washington, D.C., Chicago and Phoenix.