Choosing the Best Form of Legal Entity for Your New Business:
There are a lot of useful articles written on the different ways a business may be legally formed. Sole Proprietorships, General Partnerships, Limited Partnerships, Corporations, S Corporations and Limited Liability Companies are the most common. Before discussing these alternatives, let's take a step back and discuss when this issue is even relevant.
It is generally only the buyer not the seller who must make this decision since the seller's business has already been formed, and continues to exist. Furthermore, the buyer most often needs to make this decision when the business acquisition is being structured as an asset purchase or merger as opposed to a stock (or other entity interest) purchase. If the transaction is a stock purchase, the buyer will be acquiring the form of entity that already exists. Although stock purchase buyers will find this discussion most useful, it will also be useful to owners of businesses who are considering changing the legal form of their business, or to those who are considering forming a new business. Once you've decided which form is right for you, you'll need to decide which state to form your business in and then actually form your business.
In discussing the different legal forms, we will look at their impact on a number of relevant characteristics. Method of formation, tax impact and owner liability are some of the more important characteristics.
Some legal forms involve a separate legal entity being established, agreements being entered into and/or documents being filed with the state of formation. Some entities suffer from what is referred to as "double taxation". In this situation the entity itself must pay taxes on its income, and then the owners of the entity must pay taxes when the entity's income is distributed to them, hence the term "double taxation". In situations where there is no entity level tax, the profit and loss from the business are generally reported on the owner's personal income tax return. Effective January 1, 1997, the IRS issued final regulations that make it easier for businesses that are not corporations to avoid double taxation.
If an owner does not form certain types of separate legal entities, the owner will be personally liable for the liabilities and other obligations of the business. In most cases, when separate legal entities are formed, the owner is not liable for the entity's debts. In this situation, the owner is referred to as having "limited liability." Some exceptions to this rule exist, including in the case of the owner not following the requirements as to how the entity should be governed. This latter situation is sometimes referred to as "piercing the corporate veil." Also, to the extent an owner personally guarantees an obligation of a business, he or she would be personally liable for that obligation.
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