Why You Need A Business Entity

When starting or expanding a business, many owners wonder whether they should incorporate a business entity and, if so, which one they should use. A wide variety of information and "suggestions" are being generated on the Internet regarding the advantages of certain entities over others. However, when you cut through the flak, the primary reason for forming a business entity is to create protection against personal liability arising from your business activities. It is well known that up to eighty percent of businesses fail within the first two years. Many of these businesses, and probably yours, carry a high level of personal risk for their owners. If you are not using the correct entity for your particular business, you will be personally liable if the business fails. Do you want to list your house, car and other possessions? What about your husband's property or his salary from his regular job? Choosing the right entity for your business will prevent such nightmares from occurring. More importantly, you can sleep at night knowing that the worst thing that can happen is losing your business investment, not your home. Business Structures In the modern corporate world, there are many business structure options. The following is a brief explanation of the most common business structures. Corporations Corporations come in two basic forms, the "C" corporation and the "S" corporation. There are a number of differences, but the main one is the tax issue. In short, “C” corporations are taxed on their income and you are then taxed separately on any money you take out of the corporation. The "S" corporation "passes through" all taxes to the shareholders and the information is reported on your personal tax returns. Regardless of tax classification, a corporation is considered a separate entity from a legal point of view. This independent status acts as a shield between the business's activities and your personal assets. A practical example is that Kmart recently filed for bankruptcy. Individual shareholders did not have to declare bankruptcy and lost nothing more than their investment in the company's shares. Forming and using a corporation for your business activities will have the same effect, your personal assets will not be wiped out if the business fails. Limited Liability Company The Limited Liability Company, or as it is better known "LLC", was a very popular choice of entity in the early 1990s. LLCs are similar to corporations, but can be taxed like a partnership. In California, an LLC can have one or two owners. Regardless of the number, these owners have the legal title of "member". An LLC provides protection for your personal assets just like a corporation. Partnerships In my opinion, it is better to have a young child die than to be in a partnership. Unfortunately, many business owners enter into partnerships and don't even know it. This happens when they go to the store with another person. If no business entity is created, the law considers the business to be a partnership and treats it accordingly. Partnerships are dangerous for one main reason: partnerships provide no protection against liability and in many ways create personal liability. Under well-settled law, most partnerships are classified as "general". This simply means that all partners share in the management and operation of the partnership business. This classification can have dire results. In a public company, each partner is jointly liable for the debts of any other partner arising from the business. For example, you and your partner go to a business dinner with a client. Your partner will have a drink and then a few more. Then they get into an accident on the way home. Each of the partners is responsible for damages claimed by injured persons. That means YOU! Even if you weren't in a car, you didn't rent a car, you never saw a car and you don't drink! Partnerships are a recipe for disaster. Stay away from them whenever possible. Limited Partnerships Limited Partnerships [“LP”] are perhaps the most misunderstood business entity. A limited partnership is similar to a general partnership but allows a number of partners to limit their liability by being limited partners. It is important to note that these limited partners are limited to simply contributing capital [cash, contents, equipment] to the partnership. They cannot be involved in the active management of the business. If so, they lose any protection against partnership debts. Many limited partnerships end in disaster. If you are married to the idea of ​​running a limited partnership, you must do so in combination with corporations. This particular strategy is beyond the scope of this article, but if you wish to run a limited partnership, please feel free to contact me. Business owners should protect themselves by setting up entities for their business activities. The real challenge is identifying the structure that is best for your particular situation.