How to Choose the Right Legal Entity for Your Business

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4 min read
In our previous post, we covered some of the options for establishing a legal entity. To review, a legal entity is an association, corporation, partnership, proprietorship, trust or individual that has legal standing in the eyes of the law; as such, it has the legal capacity to enter into agreements or contracts, assume obligations, incur or pay debts, sue and be sued in its own right, and to be held responsible for its own actions. It is you, but it is not you; it is the thing that is your company. Establishing certain kinds of legal entities can help protect you from liability issues or produce more favorable tax scenarios. Last time, we looked at the pros and cons of a sole proprietorship and the different varieties of legal partnerships. Now, we are going to pick up where we left off and launch into corporations. Ready to incorporate? Then read on...

The biggest difference between a corporation and other forms of legal entities is the idea of ownership. Rather than being owned by you, the entrepreneur, if you decide to incorporate your company, it will now be owned by a group of shareholders. Furthermore, it will be managed by a board of directors and operated by officers. To incorporate, you must prepare and file Articles of Incorporation with the appropriate government offices. In all likelihood, you will still play an important role in the company, perhaps owning a controlling number of shares or serving as President or CEO. But that is not always the case. There are times when the entrepreneur decides to cede control and/or managerial responsibilities in exchange for the various benefits a corporation can provide. Let's look at some of those now:

Types of corporations

First, let's talk about asset protection. If all legal forms are filed correctly with government agencies, the owners of the corporation are not responsible for the debts or liabilities the company incurs. Another benefit is that shares of stock in the corporation can be freely sold or transferred in accordance with state and federal law. From there, further restrictions and benefits will vary depending on which sort of corporation you choose to establish: C Corporations, S Corporations, Close Corporations, Professional Corporations (PCs), Professional Associations (PAs) and Limited Liability Companies (LLCs).

Think of C Corporations as the original corporations, and all others as variants of that original. As noted above, C Corporations need to involve a board of directors and corporate officers, and the company is owned by a group of investing shareholders. C corporations enjoy total asset liability protection, but they also pay a premium in taxes. The C Corporation is set up in such a way that all revenue is taxed twice: once as revenue to the company, and again, assuming there is profit, as dividends to the shareholders.

An S Corporation is identical to a C corporation except that the owners and the board have elected to be taxed as an S Corp. The liability protection is more limited than for the C Corporation, but the tax benefit is substantial. Rather than having to pay the often-hefty corporate taxes, revenues from S-Corporations are only taxed once they pass on to the shareholders.

A Close Corporation is a relatively small endeavor, limited to a smaller number of shareholders. This type of corporation is able to forgo the requirement of having a board of directors or officers, depending on the shareholders to manage the company directly.

Professional Corporations and Associations allow groups of professionals (e.g., doctors, lawyers, accountants) to form a corporation type company that offers them the legal protection of limited liability without being liable for the actions of the other members of the corporation. In this way, it is much the same as with a limited liability partnership, with the difference being that only licensed members of the profession may be part of a PC or PA.

The last entity we will discuss is one of the most popular, the Limited Liability Company (LLC). This hybrid form is really not a corporation at all. Instead, it is a special legal entity that offers limited liability to its owners and free transfer of all interests while still being taxed as a partnership. This means it avoids the double taxation of the C-Corp companies, but still has some protections for personal assets. The main benefit of the LLC is its flexibility. Both its management and its tax structure are adjustable, while still offering limited asset protection to the owners.

Consult with the experts

Whether you decide to establish a corporation, enter into a partnership or go it on your own as a sole proprietor, you would be wise to consult a reputable attorney and discuss your options. Most of the paperwork can be found online, and you may be tempted to try to set up a legal entity on your own, but take it from us, in that way lies madness. Instead, be sure that your lawyer has experience with entity structuring and establishing corporations, and seek the advice of professionals.