Entity Formation
Choosing the right legal entity for your business provides many important advantages.
In today’s complex legal environment, business owners have a variety of legal entities to choose from. The choice of entity is an important decision, with tax, asset protection, and other implications.
If you do business by yourself, without forming an entity, then you are a Sole Proprietor. If you do business with others, but without forming an entity, then you are a General Partnership. Sole Proprietors and General Partnerships offer no liability protection, and should mostly be avoided.
The most common type of business entity is the Corporation. Corporations limit the liability of the shareholders, so that the shareholders’ personal assets are generally not reachable by creditors of the Corporation. Corporations may elect C or S status for tax treatment. A C-Corp pays a corporate level income tax, and the shareholders then pay individual level income taxes on dividends made. This double taxation can be avoided through an S Election. S-Corps pass their income on to the individual shareholders, so it is only taxed at one level. Certain criteria are required to qualify for S status, and S-Corps are subject to some additional restrictions.
Limited Liability Companies (LLCs) offer the same liability protection as Corporations, with an added bonus. Like a Corporation, the members (owners) of the LLC are protected from the LLCs creditors. Furthermore, the Members’ ownership of the LLC is protected against their own individual creditors. This is called Charging Order protection. For example, if a member of an LLC hits someone with their car and is sued, the judgment creditor cannot take the shares of the LLC from the Member. Instead, their recovery is limited to a Charging Order.
Limited Liability Companies with one owner may elect to be taxed as a Sole Proprietor or Corporation. LLCs with multiple members may elect to be taxed as a Partnership or Corporation. LLCs electing to be taxed as a Corporation may choose C or S status.
Business owners must also decide where to form their entity. For most Massachusetts small businesses, it is probably best to form a Massachusetts entity. But for some businesses, Delaware or other states offer some advantages.