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Letter of the Law

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by Neil P. Guion

It used to be so simple. All you needed was a great idea, a willingness to work and a little money, and you could be in business. If you gave any thought at all to entity selection, or the form in which your business would be conducted, the choices were not significantly more complicated than the color choices Henry Ford offered his early Model T customers, which were black, black or black.

Business enterprises were operated as proprietorships, partnerships or corporations, and everyone pretty much knew what the differences among the three general types of entities were and the reasons for choosing a particular type.

Times have changed. Now an aspiring entrepreneur is faced with a bewildering range of possibilities.

Proprietorships remain a viable and useful option for many. Partnerships have multiplied into general partnerships, limited partnerships, limited liability partnerships and even limited liability limited partnerships.

Small corporations may elect to be either C-corporations or S-corporations, and in the last decade, a new type of entity, known as a limited liability company, or LLC, has become widely available.

Add to that list a variety of hybrid types, such as limited partnerships with a corporate general partner, specialty forms such as professional corporations and professional limited liability companies, and, for the adventuresome, exotic vehicles such as offshore trusts and corporations.

Faced with this range of choices, how does one make the selection?

Before flipping a coin or forming a Turks and Caicos Corporation just because the name has panache, a person embarking on a business venture should take stock of the needs, capabilities and probable direction of the proposed venture, and select the entity type with the best fit.

This analysis will have to consider issues such as liability protection, tax treatment, employee benefits, succession plans, administrative and accounting costs, and the owner's tolerance for complexity and record-keeping requirements, among others.

There is no universal form that is best for all start-up businesses, and every form has advantages and disadvantages.

For instance, because of their simplicity, proprietorships are often used, allowing an owner to start a business with a minimum of cost and with a minimum of reports to file and records to keep. But simplicity has its drawbacks.

A proprietor has full personal liability for the debts and obligations of the proprietorship, meaning that the proprietor's home and children's education are at stake if the liabilities of the business suddenly exceed its assets. Many people have an aversion to this possibility and look for a vehicle that has better liability protection.

Traditionally, the answer has been to incorporate. In a corporation, the owners, known as shareholders, are not individually liable for the company's debts; their risk is limited to the amount they have invested. But corporations have drawbacks, as well.

A standard C-corporation pays income tax at the corporate level. Then, when the company distributes its profits, the shareholders pay income tax on what they receive, which results in so-called "double taxation."

The sting of double taxation can usually be alleviated by electing S-corporation status, but the corporate form still imposes a fairly rigid structure on the way the enterprise is managed and the way the principals get their money out.

The newest type of entity, the limited liability company, is rapidly becoming one of the most popular because it combines the liability protection of a corporation with the flexibility and tax advantages of a partnership or proprietorship.

The advantages to be gained by making a proper entity selection are significant. Before making this important decision, any budding entrepreneur should consult with legal and accounting professionals who are knowledgeable in this field.

(Neil P. Guion is a practicing attorney with the Springfield law firm of Miller & Sanford. Information and opinions expressed in the "Letter of the Law" column should not be construed as legal advice. For counseling on specific legal situations, please consult an attorney.)

INSET CAPTION:

A proprietor has full personal liability for the deeds and obligations of the proprietorship.[[In-content Ad]]

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