Starting a new business involves many decisions. One of the most important decisions is what type of legal structure to select for the new business entity.
Among other matters, the decision of what type of business entity to use will impact:
- how much it costs to form and maintain the business entity,
- the paperwork required to be filed to form and maintain the business entity,
- how much and what type of taxes must be paid in connection with operating the business, and
- the exposure the owners have to liabilities associated with the business.
Selecting the right form of business entity is a decision that should be made in consultation with your business professionals.
When a client asks me what type of entity is best for their new business, my initial answer is that it depends upon their individual circumstances, needs, and objectives. Almost all clients are interested in selecting a form of entity that will provide them with liability protection, but beyond that objective, the goals of clients generally differ and it is necessary to understand the circumstances of the client.
The factors most commonly taken into account in deciding upon the right type of entity include:
- the number of owners;
- the type of business; and
- the individual tax objectives of the owners.
Among the choices of a sole proprietorship, partnership, corporation or limited liability company (LLC), the relatively low cost of forming and maintaining an LLC, the ability to use an LLC with one or multiple owners and the flexibility available in structuring an LLC, frequently, clients determine an LLC is the best choice for them.
An LLC, however, may, depending upon the number of owners, be
- disregarded for income tax purposes and not have to file an income tax return,
- taxed as a partnership and file an IRS Form 1065 income tax return,
- taxed as a C corporation and file an IRS Form 1120 income tax return, or
- be taxed as an S corporation and file an IRS Form 1120S.
Accordingly, choosing the right tax treatment can be even more important than choosing the right form of business entity and the decision should not be made without discussing the matter with your tax professional.