By: Aaron Swimmer

The tea leaves perceive the Trump administration’s intent on a radical cut to the corporate income tax, lowering it to 15 percent on pass-through entities. Whether it becomes law, no one yet knows, but it’s as good a time as any to review and reassess your business legal structure.

Of all the decisions you make when organizing a business, one of the most critical is the type of legal framework you select for your company. Not only will this determination have an influence on how much you pay in taxes, it will also affect personal liability. What structure makes the most sense depends on the individual circumstances of each business owner.

When making a decision about the type of business to form, there are several criteria you need to evaluate.

  1. Legal liability. To what extent does the owner need to be insulated from legal liability? You need to consider whether your business lends itself to potential liability and, if so, if you can personally afford the risk of that liability.
  2. Tax implications. Based on the individual situation and goals of the business owner, what are the opportunities to minimize taxation?
  3. Cost of formation and ongoing administration.
  4. Future needs. When you’re first starting out in business, it’s not uncommon to be “caught up in the moment.” You’re consumed with getting the business off the ground and usually aren’t thinking of what the business might look like three, five, let alone, ten years down the road. What will happen to the business after you die? What if, after a few years, you decide to sell your part of a business partnership?

Here’s a quick look at the differences between the most common forms of business entities:

A sole proprietorship is the most common form of business organization. It’s easy to form and offers complete managerial control to the owner. However, the owner is also personally liable for all financial obligations of the business.

A partnership involves two or more people who agree to share in the profits or losses of a business. A primary advantage is that the partnership does not bear the tax burden of profits or the benefit of losses; profits or losses are “passed through” to partners to report on their individual income tax returns. A primary disadvantage is liability; each partner is personally liable for the financial obligations of the business.

A corporation is a legal entity created to conduct business; it becomes separate from those who are the founders of the company. This corporate status creates a benefit of personal liability avoidance. The corporation is held liable for corporate actions, not the individual shareholder. Like a person, the corporation can be taxed on profit. A “C” corporation has two levels of taxation. The first tax level occurs when the company files taxes as a business and the second level of tax occurs when dividends are given to shareholders of the corporation.  Shareholders are then required to pay taxes on dividends received from a corporation on their personal income tax return. While this double taxation is sometimes mentioned as a drawback to incorporation, an “S” corporation avoids this situation by allowing income or losses to be passed through to individual shareholder tax returns, similar to a partnership. Corporations have requirements to adhere to in terms of record keeping, decision making, annual meetings and a board of directors must be maintained.

The limited liability company (LLC) allows owners to take advantage of the benefits of both the corporation and partnership forms of business. The advantages of this business format are that profits and losses can be passed through to owners without taxation of the business itself, while still maintaining the shield from personal liability. An LLC is treated as a “pass-through” entity where members of an LLC are allowed to pass their share of the company’s profits to their personal income tax return, creating only a single layer of taxation. LLCs do not have to adhere to the same record-keeping requirements as corporations and LLCs do not have to hold an annual meeting. Furthermore, LLCs are not required to create financial statements that detail the company’s financial status. An LLC can choose to have the members of the company manage the LLC’s daily affairs, or hire non-member managers to oversee the LLC’s day-to-day activities. This allows the owners of the LLC maximum flexibility in managing the company.

So when it’s time to choose an entity type, identify your goals, weigh your options, consider the possible consequences and let Swimmer Law Associates assist you to make your decision.