Choosing a Business Entity

Jeffrey J. Presogna, CPA CVA

When considering the purchase of an existing business or starting up a new business, the new owner will have to decide what type of entity will own the business. The traditional options include: C corporation, S corporation, partnership, limited liability company and sole proprietorship. Recent legislation has provided for other forms of doing business such as the qualified small business corporation. It is obvious that the choices are numerous and complex. Each of the options mentioned above have varying ramifications regarding legal issues, taxation and capital requirements limitations. It is extremely important that the business owner consider each one separately before determining which entity is most suitable to the business.

Should a business incorporate? In evaluating whether a business should incorporate generally is dependent on how important it is for the business owners to be insulated against the liabilities of the business enterprise. The type of business, including employee and vendor relationships are key factors to be considered. Other factors to be considered are as follows:

1) Is the type of business hazardous?
2) Are there product liability issues?
3) Will the business incur debt and other liabilities to vendors and suppliers?
4) Are there any environmental issues?

There are also income tax considerations that will complicate the decision. For example, a C corporation generally pays income taxes on its taxable income as opposed to an S corporation, which pays no income taxes. The taxable income of an S corporation passes through to the individual stockholders and is taxed at the individual level. There are more than just income taxes to consider, many states levy a franchise tax and taxes based on the equity value or revenue base of a corporation.

Other issues to consider are the cost of creating the corporation and the continuous costs of corporate governance, corporate reporting and additional tax filings.

Liability protection is crucial, and the easiest way to minimize exposure to liability is to incorporate. Because of our litigious environment, every business owner should carefully consider the key liability factors that surround the business enterprise. The business owner whose single most important objective is to achieve liability protection should use the corporate entity. For the business owner who decides to incorporate, the next decision is whether to be a C corporation or an S corporation. From a liability perspective, there is no difference between a C corporation and an S corporation. The degree of liability protection is a function of state law. An S corporation qualifies for special federal tax treatment, which has been granted by the Internal Revenue Code. The corporation that wishes to be taxed as an S corporation must file an election using Form 2553 within the first 75 days of the corporations tax year. The special tax treatment is not automatic for state tax purposes. Each state has regulations regarding the tax treatment for S corporations.

The corporation does not present a fix-all situation for all types of businesses. Many procedural details must be adhered to for a corporation to be in good standing. Additionally, the corporation does not necessarily protect all stockholders from liability issues. A good example of this shortfall is the professional corporation. A professional corporation is a company that has been formed by professionals such as doctors, accountants and lawyers. Under current state laws, professional corporations do not protect their stockholders from liabilities that are created by errors and omissions by the stockholder and their employees. In many situations, the corporation will not protect the stockholders from debt owed to financial institutions because these creditors often require personal guarantees from the stockholders.

Limited partnerships can offer an effective way to control the liabilities of business owners if the corporation does not present enough beneficial reasons to do so. However, disadvantages such as lack of control in running the business and the complexities of a partnership may make the use of a corporation a more attractive choice.

Limited Liability Companies (LLC) are now available in most states. The LLC offers limited liability to its stockholders and provides protection from the double taxation issues of a corporation. The LLC also allows its stockholders to participate in the management of the business. The biggest disadvantage of the LLC is that it is new. There is not enough case law to determine how the LLC will hold up in litigation as measured against the corporation.

When selecting any form of business entity for your business, it is important to consider the cost of formation, the cost of maintaining the entity, the tax ramifications regarding the entity, the legal issues of the entity and the ease of doing business. A business owner should seek the help of a professional to assist in making this very important decision.

Jeffrey J. Presogna, CPA CVA, can be reached at jeff@vercoradvisor.com.