Which business entity is right for you?

There are a number of factors to consider when choosing an entity for your business. In Nevada, you have a number of choices, but it usually turns out that one entity type is best suited to your business goals. Limited liability company (LLC), series LLC, "C" corporation, "S" corporation, limited partnership, general partnership, all are possibilities, but each form has unique characteristics that can affect your ability to accomplish your business goals. The main factors you will want to consider are limitation on personal liability and taxation.

The LLC is popular for startups because it has characteristics that simplify management, accounting, and taxation. An LLC can be a "pass-through" entity for tax purposes, meaning that the company itself does not pay taxes. Rather, the profits and losses are "passed through" to the individual LLC "members," who report their proportionate share of profits and losses on their personal income tax returns. This can simplify accounting and reduce the total taxes paid, since the LLC itself is not a taxable entity. Income or losses are passed to the individual LLC owners, and are added to or deducted from their reportable income on their personal tax returns. In addition, the LLC form provides flexibility in distributing income/losses that is not available to a regular corporation. So, for example, you can create different class of members, where the classes can have different levels of control over the LLC and received different distributions of profits. Most importantly, an LLC, if properly organized, insulates its owners from personal liability for the debts of the company. That means that, for example, if a customer slips and falls on your premises, and subsequently sues, that plaintiff can possibly attach the assets of the LLC, but can never reach the assets of the individual owners.

The "C corporation" form is ideal if your business plan calls for issuing stock-for-services to vendors to help finance the startup, or issuing stock options as an incentive for founders and early-stage key employees. The corporation form offers the greatest flexibility for non-cash modes of compensation to founders, key employees and vendors, but that flexibility comes at a cost. A corporation is regarded as a taxable entity, such that its net income is taxable at the corporate level, and any distributions of profits to the owners are again taxable to the individuals receiving the dividend payments. This is the infamous "double taxation" that attaches to businesses operating in the corporate structure. The corporation is taxed on its income, then the shareholders are taxed again when they receive their share of the after-tax profits. Nevertheless, this entity form can be advantageous in cases where startup capital is scarce, and you need to acquire services from vendors and employees without laying out cash, or entice key employees by offering them stock or stock options. Like the LLC, any claims against the company can reach only the assets of the corporation, and not those of the individual shareholders.

An alternative to the "C" corporation is the "S" corporation, which also insulates the owners from personal liability for the debts of the corporation. To be clear, Nevada recognizes only one form of business corporation, defined in Chapter 78 of the Nevada Revised Statutes, so structurally there is no difference between a "C" corporation and an "S" corporation, meaning that both fall under the same statute (NRS 78). So contrary to the common misconception, an "S" corporation is not a different type of corporation from a "C" corporation, but rather, the "S" status is an "election" that any qualifying corporation can make so that the IRS will tax it as a "pass-through" entity, like an LLC. An "S" corporation files an informational tax return, but does not pay taxes. Any profits or losses are "passed through" to the corporation's shareholders, with no tax payable at the corporate level. This structure avoids the corporate double-taxation problem, but there are restrictions limiting which individuals and entities can be shareholders. For example, a partnership, corporation, and non-resident alien cannot be a shareholder in an "S" corporation. There are also "traps" that can cost you your "S" status defending on the profits retained in the corporation versus those distributed to the shareholders. It's important to obtain good legal advice before adopting the "S" corporation as your business entity, but if you are eligible, the tax savings can go a long way toward helping you to pursue your business goals. The takeaway here is that an "S" corporation is not a particular type of corporation, but is a regular corporation opting for special tax treatment and subject to IRS restrictions.

The Limited Partnership form can be useful in certain situations. In a limited partnership, there is a "general partner" that manages the company and controls its assets. This form is most often used in real estate businesses, for example, where the business plan is to build or acquire a garden apartment complex and manage it for current income and capital gains. The general partner will have expertise in real property management, and the limited partners will be "passive investors," providing the capital for the project in exchange for a percentage of the income and/or capital gains. The general partner will provide the management services, and make the liquidation deal when the time is appropriate. The general partner will generally take a fee for its services during the ownership of the property, and will take a priority percentage of the profits on liquidation.

In the limited partnership form, the general partner has unlimited liability for any debts of or legal claims against the partnership. For that reason, the general partner is most often structured as an entity (LLC or corporation) so that the GP's owners avoid personal liability. The limited partners invest the capital for the limited partnership to carry out its business plan, but their liability is limited to the amount of their investment. No creditor can go after a limited partner for claims against the partnership.

A more recent development in the law of limited partnerships is the "Family LP," where a family will appoint one of its members to manage the family's assets and distribute the profits according to the limited partnership agreement.

Limited partnerships are complex, and anyone proposing such a partnership or joining as a limited partner should seek legal advice to protect his or her interests.

A general partnership is, unfortunately, a common way of starting a business or taking over a family business. There are many problems with the general partnership. Most importantly, the general partnership exposes every partner to personal liability for any claims that may arise against the partnership's business, just as if each were an individual owner. That means that every partner is individually liable for the debts of the partnership, including contracts and any court judgment. So if, for example, the partners operate a market, and a customer slips and falls on some moldy asparagus, every partner is liable to the claimant to the full extent of their personal wealth. In a lawsuit, a plaintiff could attach all of your personal assets, including your home, your vehicles, even your coin collection.

Moreover, a partnership arrangement can yield unanticipated problems even if the partnership's business is successful. A perfect example is what happened to Facebook founder Mark Zuckerberg. He did not have a written agreement with his partner Eduardo Savarin, and ended up losing millions of dollars based on certain "legal presumptions" being applied to the terms of the partnership. There are many reasons to avoid the partnership form when starting a business, but if you must do so, or have already done so, you urgently need a written partnership agreement drafted by a qualified business attorney.