When an individual or group aspires to start a new business, one of the major decisions that must be made is what kind of business entity should be formed to operate the business. This means figuring out whether to form a corporation or partnership or operate the prospective business as a sole proprietorship, and, if choosing one of the former two, whether to be taxed as an S Corporation, a C Corporation, or a limited liability company (“LLC”).
Many different factors should inform the decision concerning which entity fits the goals and needs of the planned business and the individuals involved. Three areas which usually deserve great attention are (1) tax implications, (2) control of the business and (3) liability exposure.
The tax considerations bear directly on the choice of the business entity. New businesses often organize as LLC’s or S corporations to limit exposure to what is often described as “double taxation” if organized as a C Corporation. If organized as a C Corporation, the corporation is recognized by the Internal Revenue Service as a separate taxable entity that files tax returns and pays taxes on its own income. Shareholders of the corporation also pay taxes on dividend distributions from the C Corporation.
LLCs and S corporations are considered pass-through entities. As a pass through entity, the LLC and the S Corporation are not tax paying entities. Instead, shareholders of the S Corporation and member of the LLC are taxed on the income of the corporation or LLC which is “passed through” to the shareholder of the corporation or the member of the LLC, based on that shareholder or member’s percentage ownership of the corporation or LLC. From the tax point of view, LLCs and subchapter S corporations more closely resemble partnerships.
Control of the of the company or LLC should also influence which entity to form. Two people who want to have equal control may wish to form a partnership. This could be a general partnership with each as a general partner. Or the two individuals could set up a limited partnership in which they envision bringing in at a later date limited partners who may invest in the company but leave the operation and decision-making to the two general partners.
With various forms of corporations, shares could be split where no one individual has ultimate control or one shareholder could hold a controlling percentage of the corporation’s stock which, in most circumstances would be greater than 50% of the stock.
The third factor involves limiting exposure to potential liability in the event the company is sued. Again LLCs limit the exposure for each equity holder (or member) to the extent of their percentage interest in the company. Limited partnerships provide a similar limitation with regard to the limited partners. In any event, a corporation will generally shield individual owners from personally having responsibility for the corporations’ debts unless the owners are using it deliberately as a shell to avoid paying the company’s creditors.
Other factors should also play a role in the initial planning for the the organization and operation of the company.. The principals involved should consult counsel to review all options, many of them quite complex, before finalizing a decision and moving forward with the formation of whatever entity they choose.
Mr. Giddens and the other attorneys at Giddens & Gatton Law, P.C. have experience advising New Mexico business owners as to which corporate entity will best serve their company’s needs. Giddens & Gatton Law, P.C. is located at 10400 Academy Road N.E., Suite 350 in Albuquerque, New Mexico. Call the office at (505) 633-6298 to set up an appointment or visit the firm’s website at giddenslaw.com for more information.