Choosing the Wrong Corporate Entity
Corporate entities come in three categories: the good, the bad, and the ugly. But even among the good, one size does not fit all. Choosing the wrong corporate entity can cost...
Corporate entities come in three categories: the good, the bad, and the ugly. But even among the good, one size does not fit all. Choosing the wrong corporate entity can cost you time, money, and your personal assets.
The "bad" entity is the Sole Proprietorship, where the owner is personally liable for all claims against the business. If the business gets sued, as owner, you could lose more than just the company; you could lose your car, your house, everything. Though the paperwork required for a Sole Proprietorship is minimal and it is the cheapest entity to form, it is almost never worth the risk in today's litigious society.
The "ugly" entity is the General Partnership, where each partner is responsible for the actions of the other. Any partner can obligate the partnership, even if one (or more) partner(s) protests a decision. And, as with a Sole Proprietorship, personal assets may be on the line. It is also important to understand that General Partnerships can be innocently formed. There is no filing requirement. A handshake or simple business arrangement - anytime you are sharing profits and splitting losses - could be seen by the courts as a General Partnership, regardless of the intent of the parties involved. Remember, with a General Partnership you have liabilities times two. You are responsible for your own mistakes as well as your partners' mistakes. Not a good way to do business.
The "good" entities are the C Corporation, the S Corporation, the Limited Partnership ("LP"), and the Limited Liability Company ("LLC"). A corporation, LLC or LP is a separate legal entity with its own name, business purpose, and tax identity with the IRS. The corporation is responsible for the actions of the corporation, not individual owners or shareholders. As an owner or shareholder, your personal assets are protected. You are only liable for the money you put in to start the company, thus each corporation offers limited liability.
Simply filing as a corporation is not enough to protect personal assets, however. Certain corporate formalities must be followed (the same applies for LLCs and LPs) or a creditor will be able to claim that the business is a corporation in name only. In this case, the corporate veil may be pierced and personal assets claimed.
Choosing a corporate entity is a detailed, complicated process. Work with your account representative to properly set it all up. They will make sure you choose the right entity, thus avoiding a big mistake many business owners make.