Choice of Business Entity

CHOICE OF BUSINESS ENTITY

The decision to start a business can be a daunting task. You decided on the type of business you want to create, the location, and established that there is a need for your products and/or services. Next, you must decide whether you want to incorporate and what type of business entity you want to form to run your business. The selection of a business entity is one of the most important decisions that a business owner will make. Depending on the type of business, there are many factors to consider in selecting a business entity, however, among the most important factors include: 1) limited liability; 2) tax treatment; 3) management; 4) transferability; and 5) organizational and maintenance fees.

1. Limited Liability

One of the major considerations when selecting a business entity is the availability of limited liability. The business owner will want to shield his/her personal assets from the debts and liabilities of the business (this is specially true if the business will have investors). Business entities like the sole proprietorship and the general partnership do not offer limited liability, meaning that a creditor of the business can attack the business owner’s personal assets for satisfaction of a debt. Businesses that deal with hazardous materials or have high risk of liability (i.e. construction) should highly consider forming a business entity with limited liability.

2. Tax Treatment

Taxation is typically the second most important factor when deciding a business entity. The business owner will want to select an entity that allows the business owner to set up its affairs to pay the least amount of tax through careful planning. Nearly all the business entities provide some type of “pass-through” taxation. However, the Internal Revenue Code (the “Code”) provides different rules and intricacies for each. Whether the business entity is considered separate and distinct from the business owner for tax purposes will determine the way the business owner files his/her taxes on their personal income tax. For business entities that provide pass-through taxation, the business owner includes his or her share of the net income of the business on their personal tax return and pay taxes according to the business owner’s tax bracket.

Conversely, C corporations are responsible for paying taxes on its income at the corporate level and then a second level tax when distributions are made to its shareholders. This two level of taxation deters many individuals from running their business as a C corporation. Prior to the Tax Cuts and Jobs Act (the “Act”), the maximum rate applicable to Corporations was 35%. With the passage of the Act, the new corporate tax rate was reduced to a maximum of 21% and the individual tax bracket to 37%. With careful planning, C Corporations can be utilized effectively, specially for tax purposes.

3. Management

Will all the owners have the right to participate in the management of the business or will a representative be chosen to manage the business on behalf of the owners. Florida law provides guidance as to the relationship between the business owner and any of its authorized representatives, whether that may be a manager of an LLC or a director seating in the board of a corporation. Florida law allows the business owners to deviate from its default rules provided that the business owners agree in writing.

4. Transferability

In certain situations, transferability of business interest is desirable as it allows business to be transferred to new owners without disturbing the existence or continuity of the business. However, there are situations where the business owners will restricts the right to transfers, specially if the business owner does not want to do business with outsiders unfamiliar with the business or its owners. In the case of S corporations, a business owner will also want to limit transferability of its stock, as S corporations do not allow any foreign shareholders. It is important for the business owners to create an agreement covering all aspects of the business, whether that is a partnership agreement, bylaws, or an operating agreement. Absent an agreement between the owners, Florida law will govern those specific provisions. Keep in mind that the Florida Business Corporation Act requires the board of directions to adopt bylaws unless that power is reserved for the shareholders.[1]

5. Organizational and Maintenance Fees

Depending on the form chosen, the costs of organizing a business, maintaining its books and records, complying with government reporting requirements, and following the formalities for the management of the business can be substantial (i.e. board of directors meetings for corporations). In order to incorporate a business, the business owner will have to pay a filing fee to the Division of Corporations (sunbiz) and file an annual report for every year that the entity remains in business. Finally, the business owner should make sure it is following local rules, as far of the county and the municipalities.

This article provides some of the factors to consider when choosing a business entity, it is not meant to be all-inclusive. There are many other factors to consider when choosing a business entity, legal and non-legal. Always consult an attorney to discuss your particular situations. Give us a call if you have any questions regarding the business starting process and we will be glad to earn your trust.

[1] Fla. Stat. 607.0206 (2017).