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Do you the words Legal Entity make you want to hide under a blanket?
Forming an LLC was one of the business tasks I put off longest when I had my granola business. I had such a hard time wrapping my head around the legal language and how forming one would help me.
Luckily for you, I would like to welcome guest blogger, Donata Kalnenaite Esq! I am so excited to have her here to talk about your options for forming a legal entity.
Why form a legal entity?
It is a hard truth that just by having a business, you are opening yourself and your family to a lot of risk. If you have not formed a legal entity and someone sues you and wins, you could lose your personal assets such as your car or home. Since you are both an entrepreneur and a mother, the stakes are high.
Fortunately, there is a way to protect your personal assets and family – form a legal entity. A legal entity operates outside of your personal assets and thereby acts as a shield. The optimal time to form a legal entity is before you have started doing business.
However, if you are already an established business owner, it is not too late and you can still get all of the protection for yourself and your family. Common legal entities include limited liability companies (LLC’s), C Corporations and S Corporations.
Find out everything you need to know about starting a small scale business
Limited Liability Companies
One of the most popular legal entities is the LLC. LLC’s are independent of your personal assets and therefore act as a liability shield. This is very beneficial since it may keep you from losing personal assets in the case of a lawsuit. There are no limits to the number of owners in an LLC and you will not be required to hold annual meetings or record minutes at such meetings.
The Operating Agreement is a document that helps you run your LLC by specifying what you need to do in the case of certain events (e.g. you and your partners decide to sell your company). In terms of taxes, if you are the sole owner of the LLC, by default, you will be adding the profits and losses of the LLC to your personal income tax return.
However, you can also choose to be taxed as a corporation. If your company has more than one owner, you will be taxed as if you were a partner in a general partnership unless you elect to be taxed as a corporation. The LLC itself does not pay taxes but can be subject to annual tax in certain states such as Delaware. The LLC protects your personal assets by acting as a shield from liability, while also giving you tax treatment that is more advantageous that C Corporation tax treatment, which taxes you twice.
The second legal entity that you should be aware of is the C Corporation. C Corporations are legal and tax structures that are separate from your personal assets. This means that the legal entity acts as a shield that protects your personal assets.
The tax structure of this particular entity is as follows: the C Corporation makes money and is taxed itself on that income. Once the owners receive dividends, they are also personally taxed on that income. Thereby, having a C Corporation means that you will be taxed twice.
However, with a C Corporation, there are no limits to the number of shareholders you have and the shareholders do not have to be U.S. Citizens or residents. This is why C Corporations are so popular for large companies that are publicly traded or want to become publicly traded. If you are not planning on building a large company that will go as far as the IPO, it is not advantageous to form a C Corporation, mainly because of the double taxation.
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The third legal entity that you should consider for your business is the S Corporation. The S Corporation also serves as a shield to your personal assets, thus protecting your home and family from the liabilities of your business.
The S Corporation is subject to one tax – the owners report income or loss on their personal income tax returns. In return for this preferable tax treatment, there are limits on the number of shareholders and each shareholder must be a U.S. Citizen or resident. The S Corporation is advantageous because of the limited liability shield and single taxation. Furthermore, potential investors may be more willing to invest because your business is a Corporation.
These legal entities each have their own advantages and disadvantages and you must choose which one is right for your business and your vision. Forming a legal entity is neither extraordinarily expensive, nor is it very time consuming. Spending the time and money to do this now will greatly protect your family and yourself and you will surely thank yourself later.