Which Entity is Best?
Choosing the correct entity is one of the most important decisions you can make. This one decision will dictate how you prepare your taxes, how you keep your books, how much of your business’s income you keep and how much you don’t. It will dictate your profits and losses, the financial security (and safety) of your family, maybe even your health and happiness.
Do not take the decision of which corporate entity you choose lightly. There is no part of your business that will not be affected by it. This decision is so important that the founder and President of Corporate Direct, Rich Dad Advisor Garrett Sutton has even written books on the subject.
His books, as well as articles on this site are very informative and will get you started off on the right foot. Our Incorporating Specialists are very knowledgeable and here to help but we also encourage you to begin to educate yourself on the subject. By familiarizing yourself with the different entity types you will be able to maximize the benefit of your free 15-minute consultation with an Incorporating Specialist.
Entity Formation is our Specialty
Quick Comparison Chart
Limited Liability Companies (LLCs) are one of the most popular entity choices for investors and entrepreneurs. LLCs offer a tremendous amount of flexibility and, in certain key states, a great deal of asset protection.
The flexibility allows for unique management and taxation benefits. LLCs can be managed by their members (or owners) or by outside managers. As well, LLCs can choose how to be taxed – either as a disregarded single member entity (where the tax reporting flows directly onto the sole owner’s personal return) or as a multiple member partnership. LLCs can be taxed as an S corporation or C corporation. No other entity has this flexibility.
A key feature of the LLC in many states is the charging order protection. In weak states, like California, New York and Georgia, if an LLC member gets sued the attacker can force a sale of the LLC assets. In strong states like Nevada and Wyoming a charging order is a lien against distributions. The attacker can’t force a sale of the LLC assets, but must wait for distributions, which may or may not come. Check out this short video that explains how this works:
Single Member LLC
You must be very careful when you are the only owner of your LLC. Single member LLCs require extra planning and special language in the operating agreement.
One example: What happens when the single manager/member passes? Who takes over? It may be months before that is sorted out, and your business will falter without a clear leader.
The solution: Our single member LLC operating agreement provides for a successor manager (a person you pick ahead of time) to step in. There is no gap or uncertainty.
You need a specially drafted operating agreement to properly govern your one owner LLC. Corporate Direct provides such a tailored document for our clients. When it comes to business and investments, you must do it the right way.
As well, when discussing how to properly set up and use a single member LLC we must acknowledge a nationwide trend – courts are starting to deny sole owner LLCs the same protection as multiple member LLCs. The reason has to do with the charging order (explained in the full article).
Corporations have been used for over 500 years to limit owners’ liability and thus encourage business investment and risk taking. Their use for this purpose continues to this day.
You will hear about both C Corporations and S Corporations. Both are corporations with charters granted by the state of organization. The C and the S refer to IRS Code Sections. C corps feature a double taxation – one tax at the company level and another tax on profits distributed to shareholders. This double tax is why many people consider S corps, which has only one level of tax. While we like and often use S Corporations, we keenly appreciate the advantages of C Corporations. They certainly have their merit and a place in your entity structure strategy.
Limited Partnerships (LPs) have their specific uses in the world of family planning and investments. There is one limitation to the LP that, when studied carefully can be a key advantage in smart asset management. A limited partnership by definition must have at least two partners – a general partner, who is personally responsible for everything, and a limited partner, whose exposure is limited to their contribution (money) to the LP.
Unlike an LLC, S corporation or a C corporation, to gain complete protection we need to form two entities. First, the LP itself and second a corporation or LLC to be the protected general partner. The advantage comes with the general partner exercising complete control over the LP, even with as little as 2% ownership. Thus, mom and dad can gift away 98% limited partnership interests to the kids and still maintain control of the investment with their 2% general partnership interest. Having multiple general partners can add complexity that should be dealt with through proper structuring of entities.
You might be wondering why having to form an extra LLC to provide the asset protection needed in an LP would be a good thing. Why not just form a single LLC in the first place and be done with it? But there are reasons this entity choice may be best for you, and that is that the second type of limited partnership partner is a limited partner.
By definition, a limited partner is “limited” to his contribution of capital to the partnership and may not become actively involved in the business of the partnership. A limited partner may then be an owner but have absolutely no say in how the entity operates. Many clients take advantage of this feature of the LP to hand down investments to their children. Click here to see the advantages of an LP and to read a case study on “When a Limited Partnership is Best”.