5 Things to Know About Entity and Business Formation
You have an idea and want to start a business. You’re concerned about things such as liability exposure, taxes, and control over the enterprise. What should you know about entity formation?
1. A business entity is separate from you as an individual
When starting a business, it’s easy to think of your business as an extension of yourself. When you form a business entity such as a limited liability company (LLC) or S corporation, it is a “legal person” created under state law that is separate from you, the individual. Separate bank accounts, assets, records, and a distinct name (such as adding “Inc.” or “LLC” to your business’s name) must be maintained. Maintaining your business as an entity separate from yourself has certain advantages.
2. Forming an entity can help protect you from liability
Liability protection is perhaps the most important benefit of forming an entity. If you conduct business as an individual, business debts and lawsuits against the business are your personal debts and lawsuits, which puts your personal assets—potentially including your bank account and home—at risk. Forming a business entity helps ensure business debts belong to the entity, and not to you personally. There are several different types of entities with different types of liability protection. For example, an LLC or limited liability partnership (LLP) protects members or partners from the entity’s debts.
3. Different types of entities have different ownership and profit distribution structures
It’s your business. You should be able to control the major business decisions that are made and the distribution of profits. In general, partnership entities (for example: LP, LLP) share profits among the partners equally, while corporations distribute profits according to ownership interest (i.e., how much stock you own). Partners generally have authority to make decisions for a partnership, while in a corporation, shareholders elect a board of directors to make decisions. In an LLC, members have an Operating Agreement that allows them to customize distribution of power and profits.
4. Different types of entities are taxed differently
Tax considerations are important. In general, partnerships, LLCs, and S corporations are “pass-through” entities that do not pay a corporate tax, and the profits go to the partners or members where they are taxed as personal income. A C corporation pays a corporate tax on profits before they are distributed, and then shareholders must also pay personal income taxes on profits they receive. This double tax structure makes an LLC, some form of partnership (e.g., LLP), or in some cases an S corporation the best option for most small businesses. Business taxes are complicated and often require professional advice.
5. Determining the type of entity that is right for you
There is no “usual” when it comes to forming a business entity. Every business and business owner will have specific needs. In addition to selecting the type of entity, you may need assistance drafting documents such as an Operating Agreement or bylaws that fit your goals, as well as those of any partners or members you enter into business with.
Contact us today at (206) 259-1259 or email email@example.com and let us help you form your entity and start your new venture.
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