Choosing the right entity structure is one of the most important decisions that business owners can make. The entity you select determines many aspects of your business, such as the paperwork that needs to be filed, how you will be taxed, the extent of your personal liability for the business, the type of insurance that will be required, how many owners you will be allowed to have, how the business can raise money, and many others.
While a business can change its entity structure at any time as it grows and evolves and as its needs change, it is always best to choose the right entity during the startup phase. Switching entities later on can incur unintended consequences, especially if you are doing so while trying to manage a lot of different moving parts – such as might be the case during a major period of growth.
If you are planning to or you are in the middle of starting a new business in Alabama, the experienced Daphne, AL business law attorneys at Stone Crosby can help ensure that you get things started on the right foot. Call us today at (251) 626-6696 to schedule a personalized consultation with a member of our legal team.
Types of Entities for Your New Business
There are five main types of entities for Alabama business owners to consider. Here is a closer look at each one:
The simplest and easiest way to start a new business is as a sole proprietorship. As the name implies, this entity is for individual business owners and would not apply to a business with two or more owners. With a sole proprietorship, you do not have to file any business formation paperwork, but you will still need to obtain any appropriate licenses that are required for your type of business to operate.
The main advantage to starting a business as a sole proprietorship is simplicity. If you are a one-person operation and you are just getting started, then this is the easiest way to do it. With a sole proprietorship, there is no need to file a separate tax return; all you will need are some extra schedules on your personal return. In addition, you can use your own Social Security number instead of obtaining a federal tax ID number for your business.
The downside to operating as a sole proprietorship is that there is no legal separation between you and your business. For example, if you decide to hire a couple of employees and your business is sued because of the negligent actions of one of the individuals you hired, your own assets could be at risk. In addition, if your business takes on any debts, you will personally be on the hook for those as well.
A general partnership is similar in structure to a sole proprietorship, the main difference being that the business has at least two owners. Like a sole proprietorship, you do not need to file any business formation paperwork, and your taxes can be reported on your personal income tax return. In a general partnership, the partners share equally in the profits, losses, and liabilities, and again owners can be personally liable for the actions of the business.
A business with two or more owners might also opt for a limited partnership, which is a more complicated entity structure. With a limited partnership, the entity can have one or more general partners in one or more limited partners.
General partners typically have an active role in the business and can be personally liable for debts and lawsuits. Limited partners are often referred to as “silent partners”, and they are usually not involved in the company’s day-to-day operations. The limited partner(s) can enjoy some liability protection as long as there is at least one general partner who has unlimited liability.
Limited Liability Company (LLC)
A limited liability company (LLC) is an entity that combines some of the advantages of sole proprietorships and partnerships with some of those provided by corporations. An LLC requires business formation paperwork and registration, but it is easier and less expensive to set up than a corporation. LLCs can have a single owner or multiple owners (often referred to as “members”), and this entity structure provides some liability protection to its members.
For tax purposes, LLCs are “pass-through” entities. This means that company profits pass directly to the owners and can be treated as personal income on their taxes. There is also some flexibility in this area as an LLC can be treated by the IRS as a disregarded entity (typical with a single-owner small business), partnership, S-Corporation, or C-Corporation.
An S-Corporation combines many of the features of both an LLC and a corporation but without some of the disadvantages of these entities. Like LLCs, S-Corps are “pass-through” entities, and their owners also enjoy liability protection. One of the major reasons that a business may be formed as an S-Corp is for tax savings. For example, a portion of the profits from the business can be distributed to owners/shareholders as dividends, which could mean a lower tax rate.
On the flip side, the number of shareholders that an S-Corp can have is limited to 100, and foreign investors cannot be involved in this type of entity. This makes it more difficult to raise capital if the business is expanding and looking to take on additional investors, for example.
When you see an entity that is described as a “corporation” or has “incorporated” after their name, this is probably referring to a C-Corporation. This is the most complex type of entity structure, and it involves detailed procedures for forming articles of incorporation, assigning a board of directors, having board meetings, and issuing stock. On the other hand, this is the best type of entity for businesses that want to raise capital. Unlike an S-Corp, a C-Corp can attract an unlimited number of outside investors, including foreign investors.
C-Corporations are not that great from a tax standpoint because profits are subject to “double taxation.” Profits are taxed at the corporate level, then the amount that is left over is distributed to owners/shareholders and is subject to dividend or capital gains taxes.
Contact our Seasoned Daphne, AL Business Attorneys
Which entity structure is right for your Alabama business? The answer to that question will be different for each owner(s). Knowing some of the main highlights for each entity should give you a better idea of what direction you want to go. And for more detailed information and to get started, Stone Crosby, P.C. is here to help. Contact us today to set up a consultation to discuss your business legal needs.