Entity Selection for the Business Owner: Why is Choice of Entity Important?
The “choice of entity” decision is one of the most important decisions facing those who own and operate businesses. Your choice of entity will determine many important characteristics of your organization. You must identify and keep in mind your objectives when working with an advisor to select the entity that will best serve your goals. There are several forms to consider, all of which have different legal and tax consequences. No form of entity will be suitable for every type of business owner or entity.
Choosing the appropriate entity is a complex decision that depends on many factors. The owners’ needs and desires and the particular characteristics and needs of the business in question are most important. Federal and state tax consequences of each type of entity also play an important role; especially in closely held entities where the parties’ combined tax liabilities should be analyzed as part of the decision-making process. In order to choose the proper entity, it is important to understand the characteristics of each type. The following Q&A pages address the most common questions asked by new business owners.
What is the Role of an Attorney or Accountant When Choosing an Entity?
As your primary financial advisor, your attorney or accountant is there to help shape your choice of entity. The advisor’s role is to assist clients in identifying their objectives and making an appropriate entity choice to achieve those objectives. Tax practitioners should not practice law unless they are also attorneys, since they would be prohibited from providing legal advice on such aspects like limited liability.
Why Should I Seek Advice from an Attorney CPA?
An attorney who is also an accountant can provide the guidance needed by the client to consider all the necessary decision-making factors. The advising attorney will assess the tax implications within the context of the client’s specific situation. This is a critical part of the analysis and an attorney CPA will always keep in mind all tax factors, including income, payroll, sales and use, excise and estate tax exposure. Non-tax considerations include simplicity, a factor that is frequently overlooked. Too many times an entity is chosen that will save the owners income tax but at a huge administrative cost.
An attorney CPA will also consider limitation of liability and which entities provide it and assist clients with decisions regarding management and governance, capitalization, and continuity and transferability of ownership. It’s extremely advantageous to hire a seasoned Attorney who is also a CPA, since they are the most qualified legal and financial adviser capable of providing counsel in making the correct choice of entity decisions and to legally form the entity.
What Do I Need to Know When Choosing an Entity?
If you plan to start your own business, expand an existing one with a new division or perhaps create a strategic alliance with another business to help you both better serve an untapped market segment, choosing the proper entity is important for tax implications, ease of operation and liability protection, both from your customers and from each other. Your choice of entity can affect the number and identity of shareholders and partners, equity structure, control and management, as well what kind of funding you might be eligible to receive. Getting it right in the beginning is crucial. While it’s true that you can make a switch later in the game, there may be tax and other consequences as a result – so it’s important to take your time and get it right the first time. There are two important things to keep in mind:
- Entity choice is state specific. It doesn’t happen at the federal level. You incorporate or organize at the state level. The laws of the individual state matter: not all entity choices are respected or treated the same in every state.
- Your choice of corporate entity may be different from your tax entity. Incorporation or organization with the Department of State in your state does not establish a tax election with the Internal Revenue Service (IRS). For example, you can incorporate as a C corporation but elect with IRS to be taxed as an S corporation. You could also organize as an LLC but opt to be taxed as a partnership, S corporation, C corporation or disregarded altogether.
