The key principles to choosing the right business entity

Today’s topic comes from various conversations I’ve had lately with clients and prospective clients.

In these conversations I’ve been asked so many times lately “Should I form an entity?” or “What entity should I form?”.

These are valid questions, but as I’ve spoken with these families, it’s become so clear that there is so much confusion around entities.

But I’ve also realized that so much of the confusion that is out there could be solved by understanding what we're going to talk about today…

That there are legal entities and there are tax entities.

There is a lot of crossover between the legal and tax entities, but also some VERY important differences you must keep in mind in order to make the best possible decision.

Below I’ve included a graphic that lists the different main tax and legal entities.

Keep in mind, this isn’t an exhaustive list, just the most likely entities you’re going to come across.

And today we’re NOT going to dive deep into the unique characteristics of each entity, but merely talk about the differences between the general categories.

If you have specific questions about specific entities or other entities not mentioned here, shoot me an email or talk to your trusted professional. (I could be that guy! 😉) 

Ok, take a look at the list below and after, we’re going to talk about some important details.

First, before we dive in too far, I think it’s important to understand why there is the distinction.

I recognize that some of what I’m about to say may be a bit obvious, but I feel it’s important to have as foundational knowledge when discussing entities.

Legal entities primarily provide the following benefit to the business owner(s): Protection of personal assets from lawsuits and creditors.

This effectively creates a legal barrier between the personal assets of the owner and the assets of the business.

Each of the legal entities provides various levels of protection and has various rules necessary to qualify for the protection.

If you do not do what is required to qualify for the protection, courts can deem the entity of no effect and remove the barrier. It’s called “piercing the corporate veil”.

Tax entities primarily provide the following benefit to the business owner(s): Determining how the income generated by the business will be taxed.

Some entity types will have the income it generates “flow-through” to the business owners and be taxed at the business owner level.

Other entities will have the income taxed at each level in your structure. 

And some entities will have a combination of those two.

The right entity for your business or investments depends on a host of factors beyond which I’ll discuss here today to balance the legal asset protection with the potential tax benefits.

So like I said before, be sure to talk to a trusted and licensed legal professional when making these choices.

Ok, with that out of the way, let’s jump into the list.

If you need to, take a quick peek at it again and come back.

Ok let’s start by noticing the similarities between the lists.

Each list has the following entities: sole proprietors, partnerships, and trusts.

When you’re discussing or talking about these types of entities online or with a trusted advisor, make sure you’re specific about whether you’re talking about the tax or legal entity when you ask your questions.

Next, notice that the LLC is ONLY a legal entity.

So many times I’ve heard people say, “I have an LLC, what’s the tax impact?”

Truthfully, I don’t know, that’s up to you.

An LLC can be taxed as any of the tax entities above except a trust tax entity.

So until you tell me what you want it taxed as, I can’t tell you the tax impact.

And honestly, each one is taxed very differently.

Lastly, notice that there are two different types of tax corporations: C-Corporations and S-Corporations.

They are very different from a tax perspective and which one you choose can have a significant impact on the business decisions you make and options that are available to you as you do your tax planning.

The S-Corp acts like a partnership where the income “flows through” to the business owner before it is taxed.

The C-Corp is taxed at both the entity level and then by the individual owner when they receive dividends from the corporation.

That’s why the term “double taxation” is often used when discussing C-Corps.

Conclusion

Ok, I think that’s a good place to stop. 

As I said at the top, this isn’t meant to be an all inclusive article about various legal entities.

It’s meant to arm you with the key principles and differences between the tax and legal entities so you can do better research, and make more informed decisions going forward.

As always, if you want to discuss today’s topic in greater detail or have your own questions, feel free to shoot me an email and we can discuss or grab some time to meet together.

Either way, I hope you have a great rest of your week.

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Whenever you’re ready, here are a couple of ways in which I can help you save money on your taxes:

1. Book a free Strategy Call: Provide me with some financial information before the call and in 45 min to an hour I’ll give you every strategy, tactic, tool, and adjustment I’d make to your financial life to help you pay thousands less in taxes and build wealth faster.

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