There are many factors to consider when thinking about starting your own business. While a common focus of many budding business owners is capital and other financial concerns, it is vital to also consider the legal issues presented by starting a business. In this post we will be discussing the issue of the legal business entity and tackling two common questions:
- Do I need to form a legal entity for my business?
- What type of legal entity should I choose?
Question 1: Do I need to form a legal entity when starting my business?
The short answer is, it depends. If you do not take any explicit action to form a business entity but simply begin carrying out your business, you will legally be considered a sole proprietorship in the state of Arkansas. A sole proprietorship is a type of business that has no formal structure but instead is essentially seen as you. For tax purposes, all income received from the business will be viewed by the IRS as your individual income, and so there will be no need to file a separate tax return. From a legal perspective, operating as a sole proprietorship presents a risk to the business owner, given the owner’s personal assets are not protected from any liability that would arise from the activities of the business. This means that if some liability were to arise from your business, such as a lawsuit or debt, and your business couldn’t cover the cost, the owner would be personally responsible for paying for any damages, fines, and debts attributed to the business.
The other major issues to consider are tax treatment by the federal and state governments and future ownership of your business. The legal entity you choose affects the way your business is taxed, as well as whether or not you can transfer your ownership of that business in the future.
For more information on whether or not you should form a legal entity for your business, please contact us at (479) 667-7733.
QUESTION 2: What type of legal entity should I choose?
There are several legal entities to choose from and they each have pros and cons.
Partnerships
What do you think of when you hear partnership? Probably something standard, like when two or more people form a business and co-own it. And for a simple partnership, this understanding would be correct. However, in the state of Arkansas, there are many types of partnerships: general partnership, limited liability partnership, limited partnership, and limited liability limited partnership. The main differences between these entities are who is financially liable, how income is taxed by the IRS and state government, and the types of reports that must be filed with that state annually.
Corporations
In Doing Business in Arkansas, a business guide provided by the Arkansas Secretary of State’s office, a corporation is defined as:
“[. . .] a more complex form of business organization. The corporation is a legal entity and exists apart from its owners or shareholders. As a separate entity, the corporation has its own rights, privileges, and liabilities apart from the shareholders, officers, and board of directors. A corporation can buy and sell property, enter into contracts, sue and be sued. Elected officers and its board of directors manage the corporation.”
There are different types of corporations, and the differences between them lie in structure, liability, and how they are taxed. One common corporation is an LLC (limited liability company).
Limited liability companies have characteristics of both partnerships and corporations. This type of business entity allows for limited liability to its members (source). Important things to consider are the business structure, how the company will be taxed, and what kind of reports and fees will be required on the state level.
For more information on which entity to choose for your business, please contact us at (4790 667-7733.
