As we continue our series on issues to consider related to business ownership, we’ll shift our focus to legal and business formation issues. Many of our clients ask us about what type of business entity they should form and other legal questions. We’re not attorneys, and you should consult with an attorney when it comes to legal advice. But there are some basic characteristics of various business entities to learn about prior to discussing the decision with an attorney.
Choosing a business entity
A sole proprietorship is the simplest structure for a single owner. It’s actually the default business type because without taking formal action to form a business entity, your business will be a sole proprietorship. Business assets and liabilities are not separate from personal.
Personal liability is a major item to consider depending on the type of business you are running. Because there is no formal business entity, there is no liability protection for the owner of a sole proprietorship.
A partnership is a pass-through entity, and it is the default and simplest structure for two or more owners. General partners have unlimited personal liability, but in a Limited Partnership (LP) or Limited Liability Partnership (LLP), limited partners can limit their liability.
A C-corporation is a separate legal entity. It is the most formal structure offering the strongest protection to owners. As a separate taxpayer, business profits are subject to double taxation (corporate and shareholder level).
An S-corporation is a corporation that elects to be treated as a pass-through entity (no double taxation). Eligibility restrictions apply, including limits regarding stock classes (one) and the identity and number of shareholders (100 or fewer, with family aggregation).
Limited Liability Corporation (LLC)
A Limited Liability Company (LLC) is a separate legal entity that shares corporate characteristics (e.g., limited liability), but it is unincorporated. An LLC can elect to be taxed as a corporation (S or C), partnership, or disregarded entity.
Organizing and tracking transactions and other business activity
Consider appropriate methods to establish and maintain proper bookkeeping and recordkeeping practices. For example, you may want to establish separate business credit cards and checking accounts. As a tangent, there is no shortage of business credit cards with lucrative signup bonuses in the form of travel points, so you may want to do some brief research into the offerings of different credit card companies.
You may also want to start using some bookkeeping software or outsource bookkeeping to a dedicated bookkeeper. If you use a full-service accounting firm, it may offer bookkeeping services.
Choosing where to form your business
Consider whether there are reasons to look beyond your home state to form your entity. Certain states are popular choices for business formation and are known for favorable laws related to privacy, taxation, or legal protection.
Issues related to employees
Clearly outline employment terms and job descriptions, your duties as an employer, and policies to avoid potential HR issues. You may need to register with state agencies, Workers Compensation Insurance, and Unemployment Insurance.
Business partner agreements
If you are going to have business partners, implement appropriate business agreements to formalize your relationships and ownership structure. Be sure to discuss the effect of triggering events, such as death, disability, divorce, disaster, or disagreement. It is important to discuss these items with an attorney.
Business succession planning
If you have business partners, a Buy-Sell Agreement can set a course for a smooth transfer of ownership. See this blog post for a bit more detail on these kinds of agreements.
If you are planning to bring your children into the business, include tax-efficient ownership transfer strategies in your annual gifting plan and your estate plan. Family Limited Partnerships are an option, as are others.
Intellectual property planning
If your business will own intellectual property, consult an attorney regarding trademarks, copyrights, patents, etc.
While not an exhaustive list of all the business ownership legal issues you need to consider, this should be a good place to start. As you work through these issues, you’ll need the help of a business attorney, a tax professional, and a financial planner. At Flagstone, we have a lot of experience serving business owners and the unique financial issues that come with business ownership. If you’d like to enlist the help of a financial planning professional, contact us to schedule a consultation.