Choosing the Right Business Entity for Your New Business

Continued from How to Fund Your New San Diego Business.

Choosing the right business entity for your new San Diego venture is a critical step that should be made early in the process.  It’s important to diligently examine the pros and cons of each choice before deciding on what business entity to go with.  In some cases, opting for a sole proprietorship or general partnership remains a practical option.  In other cases, the owner or owners desire the creation of a more formal entity such as a corporation, limited liability company (LLC), limited liability partnership or professional corporation.  The ultimate choice will depend on the nature of the business, the number of owners and the capital investments being made.  The goal is to minimize potential liabilities including taxes.  The correct business entity choice for any particular company will depend on the individual characteristics of that company.  Your accountant and business attorney can provide guidance.  Nonetheless, there are some general issues to keep in mind:  

1328372_maze.jpgLimiting Liability:  One of the main reasons people opt for a formal business entity is to insulate owners from company liabilities.  Limiting the liability of owners encourages investment offering a distinct advantage over operating as a sole proprietorship or general partnership.  However in most cases, the owners of new businesses are required to give personal guarantees for commercial leases, loans and contractor agreements.  If so, the benefits of the formal business entity become less relevant, particularly if the business is adequately insured and intends to form an LLC or S-Corporation resulting in pass-through taxation.  If the owners have to personally guarantee loans and commercial leases, have insurance to cover civil liabilities and are going to elect pass through taxation so that they are taxed as individuals, there is little incentive to go through the expense of forming a formal entity.  

The Limited Liability Company (LLC) or S Corporation:  Most people forming new businesses end up narrowing the choice of business entity to an LLC or S-Corporation.  This is because they want pass through taxation to avoid the prospects of double taxation associated with C-Corporations.  If you are forming a new business and your main goal is to limit owner liability, the LLC is generally a good choice.  It offers more flexibility than the S-Corporation, and allows for unequal allocation of income, deductions and losses to the owners.  On the other hand, the S Corporation may offer some advantages to those concerned with self employment and FICA taxes.  If there is any doubt between these two forms of business entities, it’s best to consult with your accountant (preferably a CPA) or tax advisor for input.

C-Corporations:  C Corporations may offer some advantages to new businesses but come with the burden of double taxation (the corporate income is taxed as are the shareholders’ dividends).  This does not mean that a C-Corporation is always a bad idea.  One major advantage is tax deductible employee benefits.  In addition, there are ways to limit taxable corporate profits through salaries and benefits.  Consultation with an experienced tax professional is crucial should your business consider a C-Corporation.  If the corporation intends to go public than there is no choice but to opt for a C-Corporation.  

Partnerships:  The general partnership is most like the sole proprietorship in that the partners retain liability for the debts of the company and each partner is taxed as an individual. A general partnership offers flexibility in the management of the company and is relatively simple to form although doing so without a written partnership agreement is not recommend.  As with the sole proprietorship, a general partnership may be a sensible option if partners intend to obtain adequate insurance, prefer individual taxation and expect to personally guarantee loans.  

There are various other options such as limited partnerships (one or more general partners remain liable for the debts of the partnership while one or more limited partners do not – these are common for real estate investments) and limited liability partnerships and professional corporations both of which are designed for specific professional services.  

There is no single answer for any new business.  The key is to diligently evaluate all options with the assistance of trusted professional advisors such as a business attorney and accountant.

Continued in “The Commercial Lease and Your New San Diego Business“.

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