To Be or Not to Be ... a Business Entity

 Over the many years of my business law practice as Brian A. Ripley, Attorney at Law, I have had the honor of creating hundreds of business entities for my clients. In fact, business entity creation is often the first phase in a long-term legal support relationship between the business owner and my business law practice. The decision to place one's business in an entity, whether it's a corporation , LLC , or some other entity type, may seem straightforward but can involve complicated nuances best explained by a competent business lawyer before the decision is made.

Too many times, a client comes to me having created an entity using an online platform only to learn that they've chosen the wrong type . Other clients may have selected the right type of entity but unknowingly did not take the steps necessary to complete the process, thereby creating legal or tax problems down the road.

Most of the time, correcting these mistakes or omissions cost far more than hiring a business attorney to "do it right" from the beginning.

It's also important to understand that the correct type of business entity may vary depending on the state in which your business is located. In fact, there may be state-specific restrictions on the type of entity your business may use.

In California , for example, certain types of licensed professions (doctors, lawyers, CPAs, architects, and others) are barred from using an LLC or "general" corporation. Instead, they are required to use a "professional corporation" for their practices (or in some instances, a limited liability partnership).

Important: The failure to use the correct type of entity may place that professional at risk of having their license suspended or revoked.

Interestingly, other states, such as Texas , allow the use of LLCs for such professionals. Though if the professional moves to California, they are typically required to abandon their out-of-state LLC and create a professional corporation. A related issue involves forming an entity in a different state (e.g., Delaware, Nevada, Wyoming, etc.), though that will need to be the subject of a separate article.

Overall, the choices for business structures consist of:

A sole proprietorship is frequently used for newly formed small businesses that may not have the financial resources to set up a formal business entity. It's important to understand that a sole proprietorship does not provide any type of legal liability protection. In addition, the owner may face a significant "self-employment" tax on top of the general income tax associated with the business' activities.

A limited liability company is often a good choice for many types of small businesses and real estate investors, providing both liability protection and potentially significant tax benefits. The management of an LLC is typically much simpler than a corporation, meaning there are fewer things to "do wrong" that could expose the owner to legal and financial consequences.

There are multiple "options" for the tax treatment of an LLC (e.g., disregarded entity, partnership, S-election), which should always be reviewed by a competent tax professional to ensure optimal tax savings.

"General" corporations tend to be more appropriate for larger businesses or start-ups seeking significant investor capitalization. The management of the entity can be more complex, and also carries the risk of "double taxation" if the finances are not correctly structured and managed. But it provides flexibility in the types of equity ownership that may not be available to an LLC or partnership.

If you're thinking about a business entity for your company, practice or real estate investment property, please schedule a consultation with me and we can begin the analysis that will ensure the correct type of entity and tax treatment are selected.