Legal Business Entities–which One Should I Use?

(Please understand that the answers to these questions are general in nature and may not cover every individual situation.)

So you are ready to start a business, what should you do? If you and a friend decide to go into business together, but don’t file anything, that is called a general partnership. Both of you can bind the business and both have liability for those decisions. Judgement creditors can go after your personal assets to pay for a business debt that has gone to judgement. Small business is what fuels the state and national economy, so governments want to encourage new small businesses. So, starting several hundred years ago Britain developed the corporation, a system which allowed people to invest without risk except as to their investment and have the company run by a board of directors and officers. This is still used by most large businesses, but can get pretty cumbersome for small businesses, including being taxed twice. It does have the very important benefit of limiting the liability of the investors, so a judgement creditor can only go after the corporation assets, not the individual investor.

Limited partnerships showed up in the 19th century, generally for small projects, where investors, the limited partners, can be liable only for their investment and a general partner remains fully liable. This isn’t bad if you are a limited partner, but still leaves you individually exposed if you are in charge. In 1987, Wyoming created the limited liability company which, if managed by a manager with members only investing money, gets the benefits of a limited partnership with the addition of limited liability for the general partner (the manager) as well. Likewise, if the LLC is managed by the members and not by a manager, it is like a general partnership, except all of the members now have limited liability. And to make it even more attractive, LLC’s don’t have the corporate problems of lots of old requirements, like annual meetings, and LLC’s are generally taxed like partnerships, so no double taxation. Since 1987 every state has come up with its own LLC rules and they compete with each other to get the small businesses in their state. Utah just revised its LLC statute and is a very business friendly model. But wait, there’s more! Still trying to help the small business owner, Utah now has limited liability general partnerships, limited liability partnerships, and other options. So you live at a good time to go into small business.

There are still times when a corporation is a better option than an LLC. There is a growing area of law and strategy constantly being dreamed up by business, estate planning, and tax lawyers to take advantage of the current laws and push boundaries. The IRS is constantly playing catch-up with those new strategies. For instance, did you know that if you put real property into an LLC you can transfer it out later without any tax problems? Not the same for a corporation; the very act of moving real property out creates a taxable event. So as a rule, put real property in an LLC. If you need to, set up an LLC simply to hold your real property and use a corporation for your other business needs. There are myriad other tricks of the trade. An attorney well-versed in this area of law, and not all are, can save you many times the potential costs you pay him or her for advice in choosing what entity to use.

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