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Home > Services > Domestic Wealth Planning > Creating the Right Business Entity > What Entity Is Right For You?
Choosing the Right Entity for Your Company
What Entity Is Right For You?
When creating corporate identities, entrepreneurs have a number of options available. Each entity provides benefits and challenges for the user. Two issues begin the consideration. First, how is the risk to be analyzed and distributed within the company? Secondly, how are the profits and losses going to pass through to the owners in terms of taxation?
When setting up a legal business structure, it is important to consider management, who will make the primary business decisions? Do the owners manage the company n a day-to-day basis or are they shareholders on the board of directors? How much liability do the owners want?
Entrepreneurs must also consider pass through concepts. This concept applies to profits and losses and of course taxation. Liability is now considered a pass through concept and entrepreneurs should evaluate how vulnerable the entity will be to creditor attacks.
Taxation is another pass through concept. An accountant or attorney should determine which formation is the most advantageous from a tax standpoint. There are many intricate ways a business structure can help or hurt a company. Seeking an expert when starting up an entity is a wise investment of time and money.
Domestic Asset Protection:
As a general statement, domestic asset protection revolves around the use of Family Limited Partnerships (FLP) and Limited Liability Companies (LLC). These structures provide a remedy beneficial to debtors when the creditor asks a judge to make someone pay off a judgment or settlement. A creditor that asks the courts to have assets turned over to the creditor can only obtain a "charging order" from the court (i.e. the court cannot invade the LLC or FLP and give those assets to the creditor).
A Charging Order is a charge registered as a judgment to be held against the person's right to distributions from the entity. Charging Orders can be issued in civil business litigation, real estate and even child support. It is a business garnishment, if you will, enforcing a civil debt preventing the sale or disposal of property of profits until the charge has been cleared. It is also defined as being an "assignment of income" or as an assignment of the person's economic right to distribution from the entity.
What can't a creditor get with a charging order?
1) A charging order does not transfer the interest in the LLC to the creditor or force the debtor to sell his/her interest and turn over the sale proceeds to the creditor.
2) A creditor cannot force the LLC to sell assets.
3) A creditor cannot force an LLC to distribute income.
The Best Business Location:
Incorporating in the state where a business does most of its transactions is usually the best course of action. If an entrepreneur incorporates in one state and conducts most of their business in a different state, they will have to qualify to do that business in the other state, which will involve more fees and costs, more filing requirements, and more paperwork. If a company conducts business in more than one state, or if it is a large, publicly held corporation, it can be worth the additional cost and time to incorporate in one state but operate in another state or states.
Types of Business Entities:
The following list gives an overview of the business structures available to the first time businessperson:
Sole Proprietorship - This structure is simple because there is only one proprietor and this structure has the least amount of rules and regulations. This business does not exist outside the owner of the business and all of the owner's business and personal assets are at risk. The only advantage to this business is the total freedom for the owner to do what they want as long as they follow taxation regulations and the laws.
Partnership - A Partnership is a business relationship between two or more people. A Partnership is a legal agreement regarding the control that one partner has over another. Each person is subject to the unlimited liabilities of the other. This is an even greater risk than a Sole Proprietorship because one partner is liable not only for himself, but for the others. The profits from a "Partnership" may be distributed to the partners without any "double" taxation.
Family Limited Partnerships - A Family Limited Partnership is a Limited Partnership with special features designed to create tax savings and accomplish other asset protection goals. It is set up in such a way that you, or you and your spouse, are General Partners in the business in question, each owning a small (1%-2%) interest. "Safe assets" -- those not likely to produce liability -- such as bank and brokerage accounts, as well as other passive investments (not real estate), are generally transferred into the Family Limited Partnership.
Freeze Partnership - A freeze partnership is a partnership in which there are two classes of interests: a preferred interest and a common interest. When properly structured, the freeze partnership can help clients obtain up to a 90% discount on an FLP interest. Traditional FLP discounts max out at 20-40% depending on the assets held.
"C" Corp - This Corporation has very strict organizational rules for Shareholders, Directors and Officers. The distributions of the profits are taxed "twice", once on the corporate level and the second time at personal distribution. One of its major advantages is the limited liability for the founders, and investors are generally limited to the amount of the initial investment of contribution.
"S" Corp - An "S" Corp must have more than 100 Shareholders. In an "S" Corp the income, losses and deductions generated by the corporation can be "passed through" the corporate entity to the individual shareholders. Therefore, there is no "double" taxation. In addition, shareholders of this entity can personally deduct any corporate losses. The liability is similar to the "C" Corp.
Limited Liability Companies - This is the hybrid structure of business. Limited Liability Companies, LLC's, are subject to many of the liabilities of Partnerships and this is why an ironclad Operating Agreement is important. Limited Liability Companies may choose the status of their taxation.
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