Choices, Choices – Selecting the Right Legal Entity

By Greg Crinion

Greg Crinion

A business start up can be exciting, yet puzzling when deciding which, if any, legal entity to choose.  Sole Proprietorships, General Partnerships, Limited Partnerships, Corporations, and Limited Liability Companies are all options.  Following are five factors to consider in making your decision.

The Basics

1. A Sole Proprietorship is a one person operation where the business and the owner are one and the same.

2. A General Partnership requires two or more owners, though not necessarily equals.  The business and owners are one and the same and each partner has unlimited personal liability for the business operations.

3. A Limited Partnership requires two or more partners, some of whom may be limited or “silent” partners and at least one of whom must be a general or “managing” partner.  The limited partnership is separate from the owners.  The limited partners are liable for business operations only to the amount of their investment.  The general partners have the same unlimited liability as in a General Partnership.

4. Corporations are entities separate from their owners and have perpetual lives. Business owners are generally not liable for debts of the business.

5. Limited Liability Companies (LLCs) likewise are separate from their owners, but can operate like any of the other business forms while still providing for the owner’s limited liability.

Limiting liability of owners

A prime consideration for organizing a business entity is to protect the personal assets of the owner from business operations.  There is no liability protection for Sole Proprietors and General Partners. In these cases, the owner is liable for all business debts.

Limited Partners, LLC owners, and shareholders of Corporations can, at times, limit their liability to their investment in the business entity.  A few examples: Liability for accidents can arise if a business sells a defective product. There, the business’ assets would be at risk while the owner’s assets would be protected.  However, an owner who has a car wreck while on business places both personal assets and business assets at risk.  Liability can also arise when a lender or landlord requires the business owner to sign a personal guaranty to secure a loan, obtain a lease or pay for inventory.  The owner can avoid this liability only by refusing the transaction.

Marketing

Suppliers, customers and lenders all want to know they are dealing with a legitimate business operation. Use of “Inc.”, “Corporation” or “LLC” in a business name provides credibility.

Taxes

Corporations, Limited Partnerships, and LLCs are subject to the Texas franchise tax.  General Partnerships and Sole Proprietorships are not.

Sole Proprietors, General Partners and Limited Partners include business revenue and expenses on their personal federal income tax returns.  Corporations can choose to file returns and pay taxes separate from the owners or pass the revenues and expenses to the individual owners to include on their personal tax returns.  LLCs have the greatest flexibility and may report and pay taxes as Sole Proprietorships, General Partnerships, Limited Partnerships, “regular corporations” or “pass through corporations” while maintaining the liability protection of the LLC.

Business Formalities

Corporations require meetings of shareholders and its board of directors while other entities do not.  But, Limited Partnerships, Corporations and LLCs all prohibit commingling of business and personal assets, and use of business assets for personal purposes will quickly result in any liability limitations to be lost and the owner to have personal liability for all business debts.

The selection of a business entity is a complex decision.  Careful analysis, along with the expert assistance of a tax advisor and business attorney, will pave the way to selection of the best entity for your business.

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