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Important Considerations When Choosing An Entity Structure

Why do I need an entity? The primary reason clients set up an entity is to separate the liability of the business from the individual owners. We represent many clients who need assistance in choosing the right entity structure for their business.

What’s the best type of entity for my business? In short, it depends. There are multiple types of entities, and each one has its pros and cons. The best structure for one client is not always the best for the next as the type of business and personal objectives often differ. The most common types of entity structures are sole proprietorships, partnerships, corporations, and limited liability companies; however, these entity structures can be tailored to facilitate certain objectives. We regularly advise clients to structure their businesses based on their individual considerations. The most important considerations we discuss include the desired operating structure, personal liability limitations, taxation, and requirements and fees.

Operating Structure
The operating structure is important because it determines the framework of the entity. We ask our clients many questions including: What is the purpose of the entity? How will the entity be operated and managed? Who will make decisions? Will there be one owner, multiple owners, or classes of owners? Do we want to shield personal assets from potential personal liability? These answers weigh into our recommendation on the best structure for each client. The controlling documents, if required, are drafted in accordance with the operating structure chosen. It is important to have your controlling documents drafted by an attorney to ensure the entity operates under a clear set of detailed rules.

Personal Liability Limitations
One of the most common concerns for business owners is whether the entity type chosen offers them limited liability protections. What are limited liability protections? In summary, an entity that offers limited liability protections insulates the individual partner/member/shareholder from personal liability beyond his or her investment into the entity. E.g. A member of a limited liability company that has invested $10 into the company is only personally liable for up to the $10 invested; the company bears the remaining risk. Corporations, limited liability companies, and limited partnerships are entity types that offer limited liability protections. Note: In certain situations, a court can set aside limited liability and hold an entity’s partners/members/shareholders personally liable.

Taxation
How will I be taxed?
The answer varies based on the entity type selected. Businesses are taxed in two ways. The profits and losses are either (i) “passed-through” to the individual partners/members/shareholders and taxed at the individual rates, or (ii) taxed to the entity at the corporate rates. The latter requires the individual to pay taxes when the entity distributes funds to the individuals and results in the funds being taxed twice. There are advantages and disadvantages to each type. It is important to speak to your attorney and tax professional about how the business structure chosen affects taxation.

Requirements and Fees
Aside from a sole proprietorship, every entity is required to register with the Secretary of State in the state of formation. The registration requirements and fees vary from state to state and by entity type. Certain entity types are subject to additional administrative requirements. For example, a corporation’s requirements include filing annual reports, keeping records of regular shareholder/board of director meetings, and additional records as determined by the State’s business/corporation code in which the entity is formed and operates. These requirements can be costly and may not be necessary for all companies. A limited liability company is subject to additional requirements as well, such as annual reporting and self-employment taxes. It is important to discuss these requirements with your attorney to ensure your entity is in good standing and avoid penalties and breaches.

We recommend speaking with your business attorney prior to committing to a specific type of entity.
Please contact me (kpatel@patellegal.com) or anyone on our team to discuss how we may be able to assist you in setting up your business for success. Our transactional team also includes Anish Patel (Partner), Shameer Soni (Partner), Kishan Patel, Basel Musharbash, and Jonathan Jaskot. Each of us looks forward to working with you to find the best solution for your business needs.

 

 

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