01-Aug-2008
Business Entity TOP TEN
by Kevin G. Wick

SMALL BUSINESS PLANNING – ENTITY Q&A

1)  I currently own or am starting up a business. Do I need a separate entity for my business?
 
Yes, for a variety of reasons, perhaps the most important is protection from personal liability. There may be varying degree liability protection based on your choice of entity, but generally speaking when you form an entity, it is a legal entity or legal “person” separate from you individually. Thus, your business property and assets are separate from your personal property and assets. Recognizing the need to protect personal assets from business liabilities is one of the most important business decisions you can make.
 
2)  What types of entities are available to choose from?
 
General partnerships, limited partnerships, “C” corporations, “S” corporations, and limited liability companies (LLC’s) are among the many forms of business entities. However, each has its advantages and disadvantages. Ultimately, the choice of entity depends on prioritizing the needs of your business, and comparing how each entity satisfies those needs.
 
3)  Are partnerships an appropriate small business entity?
 
Given the other options available, in most circumstances, no, they are not. A general partnership offers no liability protection, as the general partners are each personally liable for the debts and liabilities of the partnership. A limited partnership offers some protection for limited partners, unless a limited partner participates in the conduct of the partnership business, and again, the general partners are given no liability protection whatsoever. Although Arizona is one of states that has allowed partnerships to become limited liability partnerships (LLP’s), which do give the general partners liability protection, it is not well known or understood and therefore, when liability protection is the goal, one should generally look to using either a corporation or a LLC.
 
4)  What are the advantages of a corporation?
 
Typically shareholders, directors, and officers of a corporation are not responsible for the debts and liabilities of the corporation. The corporation is a legal entity separate from its owner(s). If the corporation suffers losses, the corporation itself must bear those losses to the extent of its own resources. Such losses would not affect the personal assets of the individual shareholders, provided that the corporation maintained certain corporate formalities, explained further below.
 
5)  What is the difference between a “C” corporation and an “S” corporation?
 
The difference lies in how the corporation elects to be taxed. Corporations are taxed as separate legal entities. One disadvantage to a “C” corporation is that its earnings can be taxed twice – once on the profits earned at the corporate level, and again when those profits are distributed to shareholders. “S” corporations (along with partnerships and limited liability companies) provide pass-through tax treatment. In general, there is no entity-level tax so the earnings are only taxed once to shareholders. Pass-through entities are often good choices for businesses that are expected to generate losses in the early going because the active owners ordinarily can apply those losses against income from other sources.
 
6)  What are the disadvantages of a corporation?
 
Of the major forms of business, “C” and “S” corporations are the only forms to have the burdensome requirements commonly known as “corporate formalities.”  After filing its organizational documents, a corporation must also adopt bylaws, elect a board of directors, hold initial organizational meetings (and thereafter, at least annual meetings), and keep written minutes thereof signed by the appropriate directors and shareholders. Corporations must file an annual report and pay annual filing fees to the state(s) where it does business. If the annual report is not filed timely, the appropriate state agency assesses penalties and will eventually revoke the charter (the right to do business) of a  corporation that does not file its annual report.
 
7)  What is the structure of a limited liability company (LLC)?
 
An LLC is a separate legal entity that offers an alternative to partnerships and corporations by combining the corporation’s advantage of limited liability with the partnership’s advantage of pass-through taxation. An LLC is owned by members, managed by a manager (who is often one or more of members) and a member’s ownership in the LLC is represented by his/her respective “membership interest,” in the same manner as a partner has an interest in a partnership or a shareholder has stock in a corporation.
 
8)  What are the advantages of a limited liability company (LLC)?
 
Advantages are liability protection combined with pass-through taxation. In addition, after filing its organizational documents, there are no additional corporate formalities, allowing its members to concentrate on the business and not the legalities of entity “upkeep.”  An LLC has an added flexibility in that it can be set up as a “single member LLC” that eliminates the need to prepare and file a separate tax return for the LLC. However, this option should be used carefully and with proper legal counsel, as there is developing case law that would attempt to disregard a single member LLC and treat it simply as a sole proprietorship, potentially wiping out the limited liability protection of the LLC.
 
9)  What are the disadvantages of a limited liability company (LLC)?
 
Unless your business is set to become a publicly traded company the very near future, there are no real disadvantages to the proper use of an LLC. However, in some instances, there may be tax reasons to set up a corporation in lieu of an LLC.
 
10)  Do I need an attorney to set up my new business entity?
 
While an attorney may not be required in every instance, it simply makes good business sense to seek professional advice from both an attorney and an accountant when deciding upon the appropriate entity for any business. Consider that entity as the foundation of a successful business venture. A qualified attorney can take into account and offer advice based upon the needs and priorities of  your business, and then make certain that entity setup is done correctly the first time around. In addition, one should always consider business planning as a piece of their overall estate plan. Contact Davis Miles, PLLC today to get your planning underway.  480-733-6800