Starting a new business requires a lot of important decisions. One of these that can impact your venture for many years to come is the “choice of entity” – in what legal form should the business be organized, its assets held, and its activities conducted?
New business owners and entrepreneurs face a wide range of options when selecting the right legal entity type, and many business owners make a choice without fully understanding the legal, tax and practical ramifications for their selection.
So…C corporation, S corporation, LLC, partnership, cooperative, professional corporation, benefit corporation, nonprofit)? There are a lot of factors that should go into the decision:
- How many people will own the business?
- What kind of activities will the business perform?
- Where will the business’s activities be carried out (locally, nationwide, or internationally)?
- What kind of investment will be made into the business?
- What are the tax benefits (or consequences) available under federal, state or local tax law?
- What is my exit strategy from the business?
- Will I pursue any professional licenses or special certifications (such as the B Corp certification or women-owned/minority-owned business certification)?
Further complicating the decision is the interplay between state law and federal tax law as far as the treatment of various types of entities. Limited liability entities (such as corporations or LLCs) are formed under state law, but the taxation of the entity is generally determined under the federal tax code.1
Whatever form of legal entity you choose will likely have significant tax and economic consequences for both the business and its owners. For example, a decision to operate as a partnership will offer the owners the greatest flexibility in terms of how they share the profits of the business, but it may subject each owner to self-employment tax. A decision to operate as an S corporation has the advantage of “pass-through” taxation but will require that the corporation issue only one class of stock (meaning, each owner needs to have the same rights to income and voting) and have only individuals as shareholders, which may limit its ability to raise capital from outside or institutional investors.
At the Law Offices of Daniel T. Goodwin, we have counseled hundreds of small business owners and entrepreneurs on a various choice of entity issues. Our business clients come from a wide range of industries, including tech startups and software, construction, arts and entertainment, educational services industries, and more. We are more than well-equipped to help you set up your business on the right legal and tax footing!
1An LLC can potentially be taxed by the IRS as a sole proprietorship, or a partnership, or an S corp. You can form a nonprofit corporation with your Secretary of State, but it won’t be “501(c)(3)” tax-exempt until the IRS approves it.