Choosing the right business entity

Business owners have numerous choices when it comes to selecting their legal and tax entity structures. Trying to decide between structures, such as LLCs, C corporations, S corporations, partnerships or sole proprietorship can get confusing. And even more important, a business entity choice made a few years ago might not be the best choice today.

It makes sense to periodically review your business structure and determine if a review is in order. Here are some common reasons why you may want to change the entity structure of your business and what you should keep in mind as you review your situation.

• Limiting personal legal liability. If you’re currently a sole proprietor, becoming a corporation or limited liability company will create a separate legal entity that provides certain legal protections. If your business receives a legal summons for a claim, for example, having limited liability may protect your personal assets like your home and car from the claim.

• Hiring your first employee. Consider incorporating your business when you anticipate hiring your first employee because businesses are generally liable for their employees’ actions taken on behalf of the company. If an employee performs an act that causes an outside party to sue your business, the outside party can come after your personal assets to satisfy the lawsuit if you don’t have limited liability set up correctly.

• Establishing credibility. Having LLC or Inc. after your business’s name conveys professionalism in your business to customers and vendors.

• Accessing credit and/or capital. Incorporating can also make it easier for your business to obtain financing through banks or investors. Banks want to see that your business is legitimate and not simply a hobby. Bringing in investors also requires choice of business form that allows you to do this. It also reduces the risk banks have when individuals are tempted co-mingle personal funds with business activity. This is especially true for consultants and those in the contracting industries.

• Taking advantage of tax planning opportunities. As your business grows and evolves, you may be able to cut your tax bill by changing your entity structure. For example, if you’re a sole proprietorship with more than $100,000 in net income, switching to an S corporation could potentially decrease your self-employment tax bill. But that’s not all. You often must have basis to take losses and there is more flexibility in use of debt to create basis in some entities versus others.

• Avoiding double taxation. C corporations pay taxes on profits at the business-entity level. These profits are also taxed a second time if they are distributed to shareholders as dividends. Other business entities like sole proprietorships, partnerships and S corporations have profits taxed once on the individual owner’s tax return. Because of this, most small businesses stay away from the C corporation as an entity choice. But with changing tax rates and tax treatment by states, the right entity choice is being blurred.

Deciding whether to switch entity structures can get complicated. And changing an entity can potentially create a taxable event.

One of my primary objectives is to help you achieve your financial goals through a holistic approach that is tax-efficient in my wealth management and tax resolution practice. For more information, visit www.fredtfoxiii.com

Fred T. Fox III is a Lawton native and owns his own business.