One of the most important aspects to consider prior to starting a business is the decision of selecting the proper legal entity to operate the business. There are various forms of legal entities that can be formed in the United States. Each state applies its own laws of entity formation. Therefore, the entrepreneur must decide which one of these entities is more favorable to the business and the entrepreneur’s objectives. The laws of the state in which the business will reside will influence this decision. Specifically, the businessperson will have to determine whether to operate the business under one of the following options:
- Sole Proprietor – Individual who operates on his own, without a legal entity separate from the person. The earnings of the business will be attributed to its owner, and therefore, the owner will pay taxes for all the net income of the business.
- C Corporation – Entity in which stockholders exchange money, goods or both for a stock in the entity. The entity’s earnings will be attributed to the entity itself and later to the stockholders, upon distribution. The stockholders can be employees and/or investors of the corporation. Tax is paid at two levels, at the entity level and at the owner level.
- S Corporation – A corporation, which after meeting certain requirements, chooses to elect “S” treatment under the United States Internal Revenue Service Code. In general, an S Corporation is exempt from federal corporate tax. The stockholders declare the income, deductions, loses and creditors of the corporation in their personal income tax returns.
- Partnership (there are various types) – Relationship between two or more people who associate to develop a commercial activity or a joint venture. Each person contributes money, goods, work or skill, and in return they expect to share in the profits and losses of the business. Taxes are paid at each individual associate’s level.
- Limited Liability Company or LLC – An entity authorized under state law in some states in the United States, where the legal responsibility for the debts of the company is limited, like in the corporation, the management is in the hands of partners or the managers hired by the partners, and taxes are paid as in the partnership entity. In Florida, an LLC can elect to pay federal taxes as a C Corporation, as an S Corporation, or as a Partnership, and it may still keep its LLC status for the purposes of legal liability.
The selection of the most appropriate entity for a business will depend on various factors that affect, among other things, the legal responsibility of the entity’s owner(s) and the tax liability of the business and its owner(s). These factors include:
- The number of owners of the entity
- The citizenship of the owners of the entity
- The eventual size of the business (number of employees and earnings potential)
- If the entity will eventually become a franchise
- If the entity is set to “Go Public” (it will sell stock in the “Stock Exchange”)
- If the entity will provide fringe benefits to its employees
- If the entity will be a closely-held family business
- If the entity will purchase real estate
- If the entity will focus on being solely a service provider (e.g., a sales or consulting entity, a medical practice, etc.)
- If the entity plans to become a non-profit organization
Important: The decision to choose the right legal entity should not be made in a vacuum, and it should not be based on information provided or obtained from non-attorneys.
Registration and Maintenance Costs. In Florida, as in other states, the Department of State requires a fee to form a legal entity. This cost varies depending on the type of entity being registered. There are additional costs, like for example, registration and “good standing” certificates. The business will also incur fees for changing its name or changing the identity of its owners after its formation. In addition, the business must renew its existence annually with the Department of State. To do so, it typically submits a renewal fee with its Annual Report. As mentioned previously, there will be a penalty for not renewing before the deadline. Further, there are additional costs for converting an entity into another entity (e.g., from a corporation to LLC.) Moreover, there are additional costs for licenses and permits. The amounts due depend on the type of business, the number of employees, and the location of the business, among other factors.
* This material is an excerpt from the book “Does Your Compass Work? Practical Legal Guide for Florida Businesses.” Copyright © 2008-2015 Yasmin Tirado-Chiodini. All Rights Reserved. This excerpt is provided under a Creative Commons License.