WHAT FORM OF BUSINESS ENTITY SHOULD I ESTABLISH?
© 2001 By Douglas E. LoMonte
Are you preparing to launch a new business venture? Have you thought about what legal form your business should take? If so, you should know that there are seven options from which to choose:
• C-corporation;
• S-corporation
• limited liability company (LLC);
• limited partnership (LP);
• limited liability partnership(LLP);
• general partnership; and
• sole proprietorship.
The option that is best for you depends upon your particular circumstances. Failure to choose correctly could necessitate costly legal maneuvers and result in unfavorable tax consequences down the road. For example, converting a business from a corporation to a limited liability company and vice versa may result in untimely recognition of taxable income by the owners of the business. In our experience, the best way to avoid making a mistake is to sit down and discuss your situation with an experienced business lawyer before selecting an option. We believe strongly in the importance of that initial discussion. Often the give and take results in ideas and strategies that are hard to imagine developing in any other setting.
As for definitive rules, there are few in this area. Instead, here are some general guidelines for you to consider.
• There are virtually no circumstances under which the general partnership form is advisable. If you wish to launch a business with one or more other individuals, one of the other forms will be a better choice. For existing general partnerships, the LLP is most often indicated.
• While the trend among small business owners seems to be toward the LLC, there are still a number of valid reasons to consider a corporation. Nevertheless, over the past year we would estimate that we have organized for our clients at least two LLCs for every corporation.
• Pass-through tax treatment can be a significant advantage for many business owners. If that applies to you, we recommend that you focus on the S-corporation, LLC, LP or LLP.
• In most cases, our fee is higher for corporations than for LLCs. For the time being, the filing fees and annual reporting fees associated with Connecticut corporations are higher than for Connecticut LLCs.
• An important factor may be the jurisdiction in which you wish to organize and operate your business. LLCs are now recognized in all fifty states. Unfortunately, state laws vary and each state applies its own fee and tax structure. For example, in some states it may be more cost effective to organize your business as an LLC while in others corporations may be tax advantaged.
• If a public offering is in your business plan or even optimistically contemplated, a corporation is indicated. If this applies to you, we recommend careful consideration of both the S-corporation and C-corporation options.
• A business established and operating as a corporation can convert from an S-corporation to a C-corporation and vice versa. Often, that conversion is relatively easy. By contrast, converting an entity with a partnership tax classification to an entity with a corporate tax classification (and vice versa) is usually costly and complicated. The cost and complexity generally increases over time as the business operates.
• S-corporations and C-corporations are distinguished by the manner in which they are taxed. There are a number of specific restrictions applicable to how, when and by whom an S-corporation may be formed.
• We recommend the sole proprietorship option only in very rare circumstances. See Should I Operate As A Sole Proprietor? Who might qualify? One possibility is a consultant who works from home, is committed to not expanding, hiring employees or sharing ownership and can reasonably anticipate no significant exposure to contractual liability. A single member LLC is usually preferable to a sole proprietorship.
• All of the options except the general partnership and the sole proprietorship require the filing of forms with the Department of State (or equivalent) in the jurisdiction in which the business is organized. In most cases, forms must also be filed with the Department of Revenue (or equivalent) and the Department of Labor (or equivalent).
We hope that the foregoing guidelines are helpful. Please do not hesitate to contact us if you are considering establishing a new business. There is no charge for the initial consultation. If you have any questions about this article or would like to receive a free incorporation or LLC checklist, please email to dlomonte@wsdb.com. We look forward to hearing from you.
