When starting or expanding a business, many owners wonder if they should form a business entity and, if so, which one they should use. There is a wide variety of information and "pitches" being made on Internet regarding benefits of certain entities versus others. When you cut through flak, however, primary reason for forming a business entity is to create protection from personal liability arising from your business activities.
It is well established that up to eighty percent of businesses will fail in their first two years. Many of these businesses, and probably yours, carry a high level of personal risk for their owners. If you are not using correct entity for your particular business, you are going to be personally liable if business fails. Do you want to expose your home, car and other assets? How about assets owned by your spouse or their paycheck from a regular job? Selecting correct entity for your business prevents such nightmares from occurring. More importantly, you can sleep at night knowing that worst thing that can happen is losing your investment in business, not your home.
There are a number of business structure options that exist in modern corporate world. Following is a short explanation of most common business structures.
Corporations come in two basic forms, a "C" corporation and an "S" corporation. There are a variety of differences, but central one is a tax issue. Briefly put, "C" corporations are taxed on their revenues and you are then taxed separately on any money you take out of corporation. An "S" corporation “passes through” all taxes to shareholders with information being reported on your personal tax returns.
Regardless of tax classification, a corporation is considered an independent entity from a legal standpoint. This independent status acts as a shield between activities of business and your personal assets. As a practical example, Kmart recently filed bankruptcy. The individual shareholders were not required to file bankruptcy and lost nothing more than their investment in stock of company. Forming and using a corporation for your business activities will have same effect, to wit, your personal assets will not be wiped out if business fails.
Limited Liability Company
A limited liability company, or "LLC" as it is better known, was a very popular entity choice in early 1990s. LLCs are similar to corporations, but can be taxed as a partnership. In California, LLC can have either one owner or two. Regardless of number, these owners carry legal title of "member.” The LLC provides a shield for your personal assets just like a corporation.