Which Entity to Choose

Starting a new business is an exciting time during which an entrepreneur must make many important decisions. One of the first issues an entrepreneur must address is how he or she will conduct the new business. When I am asked to prepare the "documents" to form a business, the entrepreneur has preconceived ideas of which type of entity is best for his or her business. However, it is important for the entrepreneur to consider the attributes of the alternative business organizations through which the business may be conducted to ensure that he or she is making the right choice.

In determining which entity is right for the entrepreneur's business, he or she must consider which form: (1) provides the best protection against potential liabilities of the new business; (2) creates the least tax burden or best meets the entrepreneur's tax objectives; (3) is best situated to obtain the capitalization required for the new business; and (4) is most appropriate for the desired management structure. Most new businesses are formed as limited liability companies ("LLCs"), S corporations, or C corporations, all of which limit the owners' liability for the new business's debts or other obligations. Below is a brief description of some of the characteristics and restrictions associated with organizing a new business in North Carolina as a LLC, S corporation, and C corporation:

Limited Liability Company ("LLC")

No restrictions on who may be members (owners) of the LLC (may be owned by other business entities);
Flexible management structure (may be managed by members or can have multiple layers of management);
"Pass-through" taxation, unless election is made to be taxed as corporation;
Flexible allocation of income among members;
Not subject to franchise tax;
Members may be subject to self-employment tax; and
Must file annual report with Secretary of State (currently $200 annual report fee for LLC).

S corporation

Generally must be owned by individuals (corporations, LLCs, and other business entities generally may not be shareholders);
May not have more than seventy-five (75) shareholders;
May only issue one class of stock;
Multiple layers of management (directors and officers);
"Pass-through" taxation (income and loss of corporation reported on shareholder's tax return). Income must be allocated proportionately to all shareholders;
Must elect S corporation status within seventy-five (75) days of commencing business (otherwise will be a C corporation);
Subject to franchise tax; and
Must file annual report with Secretary of State (currently $20 annual report fee for corporations).

C corporation

No restrictions on who may be shareholders (individuals, trusts, and business entities may be shareholders);
Multiple layers of management (directors and officers);
Subject to double taxation (shareholder dividends taxed at corporate and shareholder levels);
Subject to franchise tax; and
Must file annual report with Secretary of State (currently $20 annual report fee for corporations).

The general descriptions of the attributes of corporations and LLCs set forth above are not exhaustive and are subject to certain exceptions. Also, some entrepreneurs may find that their businesses will be better suited if organized as a different type of business organization, such as a sole proprietorship, partnership, or a limited partnership. Accordingly, in choosing the proper entity, the entrepreneur may be well-served in consulting his or her attorney and/or accountant to discuss which business form is best for the new business.