2004 Fall/Winter Volume No. 4
Business Structure Options
The problem with a sole proprietorship is that it offers few liability protections under the law for you, your business, or your family. A lawsuit against a sole proprietor is actually against the owner’s complete personal assets—not just his or her business—while a lawsuit against a well-conceived legal entity may only involve that entity’s assets.
It could take a very smart (and expensive) lawyer, accountant, or certified financial planner to properly structure your business. But it may be the best money you ever spend if your business structure ends up saving your life’s work from ruin!
What business entities should you consider and why?
Remember, you could end up across the courtroom from a very smart and determined lawyer who wants to take as much as possible. That’s why you need to hire a very smart and determined expert long before any thing like this happens to structure your business in such a way that will make losing it less likely.
So how do you protect what you have for your family today, and pave the way for other family members to continue the business when
you are gone?
Business structure options
There are essentially five structures to choose from that can limit personal liabilities when running a business. They are corporations, Sub Chapter S corporations, limited partnerships (including family limited partnerships), limited liability companies, and limited liability partnerships.
When you form a corporation you are creating a new entity with a life of its own. It has a defined name, mission, purpose, address, and even it’s own tax I.D. number. It can be formed with one or more shareholders. There are very specific rules of how a corporation must operate.
If any of these rules are ignored, a court may decide to ignore the corporate structure when deciding liability issues. The biggest problem with a corporation for small companies is the issue of “double taxation.” Corporate profits are taxed by the government before the entity pays shareholder dividends. Those dividends are then taxed again as income.
SUB CHAPTER S Corporation
This unique entity is favored by many small businesses because profits and losses flow directly to shareholders. It is not taxed as a separate entity, so you avoid the problem of double taxation. It is a structure reserved for small companies because the government puts a cap on the number of shareholders the company can have.
(including Limited Family Partnerships)
In general partnerships, partners may be liable for each other’s debts and legal problems. A limited partnership can alleviate this problem. However, because of laws governing limited partnerships in tax filings and other issues, it can be one of the most expensive entities to operate. It does however free the company from some of the procedural operating constraints required for corporations. It can also be useful in family businesses for estate planning purposes.
LLC’s were developed by states that wanted to give small businesses the tax advantages and liability protection of limited partnerships without the shareholder restrictions placed on Subchapter S Corporations.
Limited Liability Partnerships (LLP)
These entities provide the simple operating rules and low cost of general partnerships with the liability protection of a limited partnership. While this entity can protect you from liability for your partners’ actions, it will not protect you from your own liabilities.
How do I choose?
Any of these options could protect your assets from worst-case scenarios. However, the reasons to establish one of these structures over another, or over a sole proprietorship or general partnership is so complicated, that you will need to discuss your individual situation and objectives directly with a certified expert.
Beware of discount, one-size-fits-all corporation structures or limited liability structures that can be purchased over the Internet or from an ad in the back of a business magazine. While they may offer great savings, the protection they provide is not so great. A smart lawyer can easily shred a generic legal structure. Make sure your legal entity is developed by an expert specifically for your business.
Also be suspicious of lawyers, accountants or financial planners who are not fully certified or accredited in business law.
Corporations and partnerships are designed to help small businesses survive no matter what bad luck might befall them. To find a legal expert who can help you restructure, talk to your accountant or lawyer. Ask if they specialize in this field. If not, ask them to recommend someone who does.
Key to Success
Careful Planning Is Essential. Before embarking on any legal decisions that will affect your business and your family, consult with an attorney who is skilled in the area of small business law. Determining the best structure for your company requires careful analysis and strict compliance with IRS regulations. This article is for informational purposes only and should not be used to make personal legal or tax decisions. The information may not apply to your particular business or situation.
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