How Do you - Decide on a Legal Entity

Apart from the original decision to go into business, perhaps the other most important decision is which entity the business will be run under. When an entity has been selected, the legal implications will need to be considered.

Some structures have very little legal requirement (as far as compliance is concerned) while others have to follow regulations and be accountable to government departments.

The decision you make will be based on factors such as the number of owners in your business, the desire to limit your exposure to liabilities of the business and the need for tax savings.

There are 3 main entities involved:

  1. Sole Proprietorship.
    This is the simplest form of business entity. Here, one or two people own the business and operate as a sole proprietorship. No licenses or no legal involvement is required, except with the IRS for taxation and Sales Tax. The income of the business is taken as income belonging to the proprietor and the proprietor pays the tax. It is generally easy to start this type of entity, but there is no protection from creditors of business debts should things go wrong in the business.

  2. Partnership.
    Here there are 2 or more people who join together to own and run a business. Each partner assumes full responsibility for all the debts of the business. The partners share the profits as well as the losses. They share the assets as well as the liabilities. The taxation is similar to sole proprietorship. The profit is divided amongst the partners who each pay personal taxation on the income. The partnership itself is not taxed. The exposure to liability is unlimited, as in the sole proprietorship, so if things go wrong creditors and others with claims against the business can sue the partners individually, or together, to recover any losses incurred.

  3. Limited Liability Corporation 
    The limited liability entity was created to give protection from liability to owners of a business. A limited liability corporation is a separate legal entity, or legal person, in the eyes of the law. The owners or shareholders in the corporation are merely holding an interest in the business. They are not the business. The benefit of a limited liability corporation is that the shareholders in the business do not have to pay any more than they owe on their unpaid shares (if they are unpaid) in the event of the corporation failing. This is probably the most common entity used if a business owner is serious about separating the family assets from the business. If the corporation fails, because it is a separate person it cannot call on the assets owned by the owners or their families.

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