One of the first decisions an entrepreneur should be making is the selection of the right form of business entity. This is a critical decision because of its ongoing legal and tax consequences.
Liability protection is the most important non-tax consideration in the business entity selection process. The business owner has to have a shield or umbrella of liability covering his or her business activities in order to protect their personal assets from liability exposure. There should be no debate over whether or not to create a liability-shielded entity in which to operate the business or to go “bare” and operate as a proprietorship or a general partnership. If you intend to build a successful business, then you should either incorporate or set up a limited liability company (LLC).
A corporation is a separate legal entity that is state chartered and created. There are two types: a C Corporation and an S Corporation. For tax purposes, a C-Corp is taxed as a separate entity from the owners. An S-Corp is a pass-through entity that is taxed like a partnership. For legal purposes, there is no distinction between a C-Corp and an S-Corp.
The major advantage of a corporation is that it affords a shield of liability protecting the owners from claims against the business. It is a perpetual entity and, therefore, is also a good vehicle for estate planning purposes.
When it comes to taxes, the major disadvantage of a C-Corp is “double taxation,” where the profits are taxed at the corporate level and then again at the shareholder level if they are distributed as dividends. In a closely held corporation whose owners are involved in the corporate business, the problem of double taxation can be avoided by taking the profits as salaries. If there are passive investors such as shareholders who do not directly work for the corporation, double taxation remains a major problem.
There is no double taxation issue for an S-Corp since it is taxed as a pass-through entity and profits are reported on the business owners’ personal tax returns. There are several different tax scenarios for LLCs, so you should consult with your business attorney and CPA before making a decision on the tax structure for your LLC.
Whether you’re starting or already running a business, the best time to hire a lawyer is before you need one. Having a business attorney that understands the individual needs and unique circumstances of your company is key to helping your business thrive and prosper. If you are interested in learning more about legal protection strategies for your business and how we work with you as a partner in protecting your company, contact a Creative Business Lawyer®today to schedule your comprehensive LIFT™ (legal, insurance, financial and tax) Foundation Audit.