Business Entities

The E. Samuel Wheeler, CPA advantage

Our firm is equipped with the expertise to assist you in making the right business entity fit.  In addition, we can:

• Apply for an Federal EIN number

• Apply for a Resale license

• File all necessary state forms

• Setup an accounting system that fits your needs

Analyzing Objectives When Selecting Type of Entity

One of the first decisions an individual makes when starting a new business is choosing the type of legal entity to own that business. Options include several traditional choices: the C corporation, the S corporation, the partnership, and the sole proprietorship. In addition, other forms of doing business are available, including the limited liability company (LLC) and the limited liability partnership (LLP). Some new businesses may even be structured using two or more of these entities to maximize the advantages offered by each.

Before make a decision you must make sure all aspects of the business needs are considered, that all major tax and non-tax issues have been addressed, and that all possible entity choices have been considered. You must keep sight of your business objectives.

Establishing a Profile of the Start-up Business

Clarifying Your Business Goals and Objectives: To select the appropriate entity, you must determine your goals and objectives. The proper entity is one that fits with your total tax, financial, and legal situation and meets the client’s business objectives of what the entity is intended to accomplish. We can help clarify your business objectives and recommend entity choices that will meet those goals.

Most goal statements in entity selection relate to one or more of the following basic business objectives (these goals are discussed in the remaining parts of this section):

a. Insulating business owners against legal liability.

b. Minimizing taxes (including the avoidance of double taxation).

c. Providing ease of formation, operation, and administration.

d. Facilitating a future change to a different entity structure.

Other important goals include gaining access to capital funding through ownership flexibility, and facilitating future business succession to family members, fellow business owners, employees, and others.

Identifying the Nature of the Your Business Operations

    You must be familiar with the underlying factors of your operations, such as the—

a. nature of the business,

b. number of and relationship among the organizers,

c. capital funding needs and the availability of capital,

d. amount and nature of the assets to be contributed at inception, and

e. participation of organizers in management.

Insulating Business Owners against Legal Liability

A critical issue that must be addressed early in evaluating entity choices is, “How important is it for the business owners to be insulated against the liabilities of the business enterprise?” The need for a liability shield must be weighed against other concerns relating to the choice of entity decision, including (a) suitability for intended purpose (e.g., operating a retail store or investing in real estate), (b) tax implications, (c) tax compliance costs, (d) set-up costs, (e) ease of operation, and (f) operating costs.

The issue of liability exposure (and measures to minimize that exposure) should be discussed with competent legal counsel. The nature of the business itself and the characteristics of the owners and employees are the key factors in this analysis. The table below lists specific indicators of liability exposure for business owners. The existence of one or more of these items indicates a need to (a) avoid the activity leading to the risk exposure or (b) limit the owner’s liability with a limited liability entity or other asset protection strategy such as insurance.

Common Sources of Liability Exposure

• Debts to creditors, vendors, and suppliers.

• Employing others.

• Employees whose actions can create liabilities (e.g., employees who drive vehicles to make deliveries).

• Hazardous nature of the business (e.g., toxic chemicals are handled or heavy equipment is used).

• Product liabilities (e.g., the products are hazardous by nature or can be mishandled in ways that can result in injuries or damage to property).

• Environmental liabilities (e.g., almost any manufacturing or processing business and any business owning real estate that may be contaminated or polluted).

The choice of business entity is one way to address liability concerns. Other methods include purchasing adequate insurance, hiring competent and trustworthy employees, using competent legal advisors, ensuring that employees are properly trained, properly maintaining buildings and equipment, and implementing other asset protection strategies.

In today’s litigious environment, liability protection is often critical, and the surest and easiest way to minimize owner exposure to liability is to incorporate. This is because the legal obligations of corporations and their owners are well established under existing law. If your single most important objective is achieving liability protection, the use of a liability-limiting entity is essential. In such cases, the decision becomes choosing between a C corporation, an S corporation, and an LLC.

Corporations Are Not Perfect Liability Shields. Certain procedural details must be followed to establish that the corporation and its owners are separate entities. These include drafting articles of incorporation, bylaws, and minutes; maintaining a corporate bank account; and filing corporate income and franchise tax returns. Meeting these requirements involves time and expense, but is necessary to support the corporate structure. Otherwise, the existence of the corporation may be ignored for legal and tax purposes, which is sometimes referred to as “piercing the corporate veil.” Corporate status can be pierced for other reasons as well (e.g., where the corporation is undercapitalized).

The issue of veil piercing is unique to closely held entities. Large publicly traded corporations are rarely, if ever, disregarded. Closely held corporations are subject to piercing for many reasons. However, there are certain standards that have been developed over many years which provide guidance as to the best methods for preventing the loss of a corporation’s separate identity.

In many cases involving closely held businesses, the use of a corporation does not protect the owners from liability or debt owed to banks and other financial institutions, because these creditors often require the owners to personally guarantee such debt. This does not mean that a corporation offers no liability protection in such circumstances. For example, a corporation generally still protects owners from product liabilities and liabilities resulting from the acts of employees.

Generally, under state law, the use of a corporation does not protect professionals (doctors, lawyers, accountants, etc.) from liability for their own professional errors and omissions or for their own malpractice.

C Corporations versus S Corporations

 For liability protection purposes, there is no difference between a C corporation and an S corporation. The degree of liability protection offered by any corporation is a matter of state law and is not related to its tax status under the Internal Revenue Code (IRC).

The procedures for incorporating an S corporation and a C corporation under state law are the same. An S corporation is simply a corporation that qualifies for special income tax treatment (e.g., freedom from double taxation of corporate income) under the IRC and then affirmatively elects S corporation status. Once it has been decided that incorporation is appropriate because of liability concerns, the next issue is to address whether the potential tax benefits of S corporation status can or should be used.

What about Limited Partnerships and Limited Liability Companies? Limited partnerships can be an effective way to control the liability of owners. However, at least one of the partners must be a general partner that is, at least theoretically, exposed to unlimited liability. In addition, limited partners cannot be too actively involved in running the business without losing their liability protection. These factors, along with the complexities of partnership taxation, may make the use of a C corporation, S corporation, or limited liability company (LLC) a more attractive choice.

LLCs are available in every state. In theory, LLCs are attractive because they combine the best attributes of corporations and partnerships by offering limited liability to all owners (like S corporations), flexible ownerships structures (like partnerships), and avoidance of double taxation (like both S corporations and partnerships). Furthermore, unlike limited partnerships, all owners can fully participate in the management of the business without the threat of losing their limited liability protection. The major drawbacks of LLCs are that the true degree of liability protection offered is somewhat uncertain since the laws are evolving, and members of LLCs that conduct an active business will generally be subject to self-employment taxes. Accordingly, corporations still offer more time-tested assurance that the benefits of limited liability will be realized. State franchise tax cost must also be considered.

Comparison of Various Business Entities

The following table illustrates the major differences in operating a business as a partnership, C corporation,

 proprietorship, LLC, or S corporation.