BUSINESS ENTITIES, GENERAL INFO, & PLANNING ©
If you own a business you should not overlook it in your estate planning. You will want to give serious consideration to the best entity type for your situation. Choice of entity is the subject of this article. But you should also give some thought to protecting valuable business assets from legal problems which the business may encounter. Business asset protection is too complex to discuss in depth in this article, so you may want to discuss that subject with a NAFEP Associate. The rest of this article will focus on business entity choices and explain their benefits, strengths and weaknesses.
Business Entities in the U.S. :
- Corporation (C, PSC and S)
- Partnership (Limited and general)
- Limited liability company (LLC)
- Proprietorship
In the list above the proprietorship is considered an informal business arrangement; no formalities other than possibly a business license are required. You have a proprietorship just by simply "going into business", with no formality other than a name. The other entities listed above require some additional formalization. Limited partnerships (LP, FLP LLP), limited liability companies (LLC) and corporations are official entitles in each state of the U.S., created by statutes from the state legislature, and they require official registration with the state. These entities are accompanied with formal rules from the state regarding the entity's structure and operation, along with some state supervision and annual taxes or registration fees.
Why Formal Business Entities Are Important. There are four major uses of and reasons for forming a formal business entity:
- Limiting your personal liability from legal problems of the business. This is termed "limited liability" and is granted by state statute (or case law with trusts). This feature usually prevents debts and liabilities of the business from being collected from the owners and officers personally (though there are some exceptions).
- To provide a simple method of dividing ownership interests among multiple owners.
- To provide a centralized management system when there are multiple owners.
- To take advantage of business tax breaks that are only allowed to legal entities. These breaks include various fringe benefits, health insurance, pension plans and profit distributions which may not be subject to self employment taxes.
Who Needs a New Business Entity?
Sole proprietors and the self employed don't have multiple owner issues, but they do lack limited liability and special business tax breaks. Lack of limited liability is often a major threat to the business owner. There are six entities or groups that businesses deal with, and any one of them is a potential threat to sue the business. These groups are: customers, employees, creditors, sub-contractors or contractors, competitors, and regulatory governmental agencies. If you deal with any combination of these groups as a proprietorship or through self employment, as a licensed professional or as the general partner of a partnership, you are a candidate for a formal business entity. Your status as proprietor, self employed or general partner provides no limited liability at all. You may be in great personal danger from business related lawsuits. Also, you may have mismanaged an existing business entity to the extent that your limited liability is in jeopardy or is non-existent. If so you may be a candidate for a new entity as the best way to distance yourself from the problems that this mismanagement created.