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Carefully consider the options when forming a business, P.2

Last time, we began looking at the topic of business formation and the various types of entities available. As we noted, selecting the correct business form is critical to ensure the success of a business, as it impacts important things like, ownership, liability, and taxation.

While sole proprietorships and partnerships are relatively simple and straightforward, corporations and limited liability companies are more complicated in terms of formation, dissolution, reporting requirements, and various other aspects of business. For this reason, it is more difficult to change from these business forms, and the decision needs to be carefully considered before moving forward.

Corporations are their own legal entity and they exist apart from the owners. Corporations are separate for purposes of liability, though owners may be held liable in some circumstances. Owners can be held liable, for instance, when they take actions outside the scope of their legal authority, which means beyond the scope of the corporation’s Articles and Bylaws. Corporations are taxed at the corporate level, though shareholders are also taxed as well. Formation of a corporation requires submission of Articles of Incorporation with the state.

Limited liability companies, like corporations, also protect owners, called members, from personal liability, but they are taxed differently. Rather than being taxed at the corporate level, they are usually taxed like a partnership, provided they have at least two members and do not elect to be treated as a corporation. An LLC is also filed by filing documents with the state, and an operating agreement must be written up, distributed to members, and kept with the company’s records.

Depending on the needs and circumstances of the business, it may be possible and desirable to select between several business forms. When this is the case, it is particularly important to make a wise choice, as changing the business form later on can be complicated, particularly when a corporation or LLC is initially formed. Working with an experienced attorney is important not only to receive guidance on the best form a business should take, but to address problems that arise after the business is formed.

Sources:

California Secretary of State, Starting a Business—Entity Types, Accessed March 22, 2017

IRS, Limited Liability Company, Accessed March 31, 2017. 

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