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How to Choose the Right Entity for Your Business

Updated: June 3, 2022

Est. Reading: 7 minutes

Choosing the correct business structure for your needs is an incredibly important task for business owners. The structure you choose will determine your tax obligations, liability protection, management structure, and paperwork requirements. There are a number of different types of entities to choose from, some are easier to form but offer fewer legal protections while others take more work to launch but offer greater protections or tax rates. An experienced business attorney will be able to help you determine which type of business structure is appropriate for your needs and go through the process of establishing your registered business entity.

At Monahan Law Firm we offer our legal services to help you determine and establish the right choice of business entity and formally establish the ownership structure. Our expert team can help you manage the process of establishing your business and avoid common mistakes people make to save you both time and money. Contact us today to schedule an appointment!

Types of Business Entities

There are several different types of business entities to choose from, each with its own benefits and drawbacks. We'll explore them below:

Sole Proprietorship

This is one of the most common business entity types and gives you sole ownership over your business. If you are engaging in business activities but fail to register as any particular type of business structure you will be considered a sole proprietorship by default.

A sole proprietorship is the simplest business entity to form but offers the fewest protections for the owner. Without forming a separate entity you, as the sole owner, may be liable for any debts and obligations are taken on by the business. You will likely shoulder the financial obligation of the business independently as well, as banks are less likely to offer loans to sole proprietorships.

an image of a lawyer reviewing a business contract

Partnership

Partnerships are the most basic type of business structure for ownership groups. They can be divided into two different types: limited partnerships (LPs) and limited liability partnerships (LLPs).

Limited Partnership

A limited partnership leaves one partner with unlimited liability while all other partners have limited liability from the business. Due to this imbalance in responsibility, most LPs grant the partner with unlimited liability more control over the business in the partnership agreement. Profits made from LPs are taxed after they have been divided amongst the owners. Limited liability partners will include this on their personal income tax return, while the partner with unlimited liability will have to file as self-employed.

A limited liability partnership follows a similar structure, but all owners have limited liability from the business rather than one maintaining unlimited liability. LLPs give every partner some protection from actions taken by another partner, as they will not be held responsible for debts taken on by the partnership.

Limited Liability Company

A limited liability company (LLC) offers a mix of benefits from two different business structures: corporation and partnership.

An LLC grants you a greater level of protection for personal assets, such as your savings, home, or vehicle, in the event of lawsuits or bankruptcy by the LLC. Both profits and losses from the business can be passed on from the business entity to your personal taxes, but they must be filed as self-employment taxes along with the extra obligations those carry.

When an LLC in Arizona undergoes ownership changes (a partner leaving the group, adding a new partner, or a transfer of ownership) you are required to submit documentation showing the changes in circumstances. An LLC provides a number of legal rights and protections to its members and it is critical that you document these changes and stay up to date with them. Your business attorney will be able to help you navigate the different situations as they come up.

Corporations

Corporations are a popular choice for businesses that could be considered high or medium risk. A business that plans to raise money or go public through stock sales will often be formed as a corporation. There are several different types of corporations, each serving a different purpose, outlined below:

  • C Corp - This establishes the business as an entirely separate legal entity from its owner or ownership group. Due to this, they offer a much higher personal liability protection in the event of bankruptcy or lawsuits. They also require substantially more work to run, with more strict requirements for operations processing, income reporting, and record keeping. Corporations also pay taxes directly on their profits, unlike sole proprietorships and partnerships. There may be situations in which corporations are subjected to double taxation when their profits are taxed and any dividends paid out to shareholders are taxed on their personal tax returns.
  • S Corp - This creates a separate business entity much the same as a C corp, but is a special case that was made to avoid the problems C corps can have with double taxation. Profits and certain losses can be passed through to the individual tax returns of the ownership group without having corporate taxes deducted first. S corps require even more work than C corps to operate, as documentation must be provided to both state and federal tax agencies to take advantage of the benefits they offer.
  • B Corp - Benefit corporations are subjected to the same taxation as C corps, but have entirely different requirements governing their operational purpose and transparency. B corps are held to a standard of turning a profit while also providing a public benefit. An annual report is required in Arizona to monitor the public benefit provided by the corporation. This report is measured against a third-party standard to determine the impact.
  • Close Corporation - These are similar in function to a B corp but with fewer rules regarding their corporate structure. They are typically operated by a small collective of shareholders rather than a board of directors and are not publicly traded.
an attorney reviewing business documents at his desk

Why Choosing the Right Entity is Important

While choosing a business structure may seem overwhelming at times, it plays a critical role in how your business should be run. This choice will impact everything surrounding your business, from your own personal liability, to taxation regulations, to everyday operations. The goal in selecting the business entity is to strike the right balance between benefits and protections.

While you can change a business structure down the road, it is best to get it right the first time around to avoid the hassle. It is in your best interest to work alongside a knowledgeable business formation attorney, in addition to an accountant, to ensure that you make the best decision for your business.

Learn More: Questions to Ask a Lawyer When Forming a Business

Mistakes to Avoid When Forming a Business

A lot of work goes into forming a new business. While it is easy to get bogged down in the details, it is absolutely critical that you maintain a view of the big picture. Keep the following mistakes in mind to avoid landing yourself in trouble in the future.

Not Forming a Business Entity

While you can avoid creating a business entity and be automatically assigned as a sole proprietorship, you should always go through the work of deciding which structure is best for your circumstances and file accordingly. This will help you limit your legal exposure during the operation of your business and avoid unnecessary legal liability for both yourself and your personal assets.

Not Doing Your Homework

There are a number of different business structures to choose from, from sole proprietorships to different types of corporations and partnerships. This is every bit as important as writing your business plan or determining your location. You will want to take the time to fully understand the different types of structures and determine which is best for your business. Choosing the wrong type of entity could set you down a bad path for your business before you even open.

Not Thinking Long-Term

It is easy to get caught up in the short-term planning when you decide to start a business. This can be a serious mistake when structuring your business. For example, if you know that you intend to attract investors for your business to fuel growth, you will want to form an entity that encourages this such as a C corp. If you get too fixated on the short-term with your business it is easy to lose sight of the big picture and end up in trouble that you could have avoided by thinking things through from the start.

Not Looking Beyond Tax Benefits

Different types of business structures can offer significant tax advantages over others. While this is an important consideration while forming your business entity it should never be your only focus. Certain entities may offer you fewer tax benefits in exchange for greater personal liability protection and government requirements that align more closely with your business model. Consider the goals you have for your business while looking over the common types of structures so you can find a balance that is best suited for you.

Not Forming Specific Agreements

It is common for people to go into business with friends or family. You can quickly establish an LLC or partnership to operate your business and tackle any issues as they come up. This is a serious mistake. You should take the time to consider different outcomes, no matter how unlikely they may seem, and draw up terms for how to handle disagreements or separations between the ownership group.

an attorney filing business formation paperwork

These mistakes and many more are incredibly common for business owners to make when considering a new venture. Fortunately, they are also easy to avoid by taking the appropriate time to plan and consider all of your options and the different scenarios you can face as your business grow.

How an Attorney Can Help You Form Your Business

Deciding on the right type of business entity can be confusing and difficult, especially if you have never started a business before. Fortunately, a qualified business attorney has the knowledge to help guide you through the process and offer advice for your situation. In particular, they will be able to assist you with:

  • Understanding the different types of business entities and determining which legal structure is best for you.
  • Drafting or amending partnership agreements, articles of incorporation, or articles of organization as appropriate for your new business.
  • Completing and filing the documents you will need to submit to the government prior to opening.
  • Ensuring you have all the required permits and licenses you require to start your business.

At Monahan Law Firm, our team of experienced Glendale business lawyers is ready to offer their services to help your business succeed. Whatever type of business structure you need, we have the experience and knowledge to assist you through the process of setting up your business entity and ensuring you have everything you need before you open. Call us today at 623-300-2727 or schedule an appointment online to meet with one of our attorneys and see what we can do for you.

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Attorney Patrick Monahan

Patrick Monahan

Patrick Monahan is the managing partner of Monahan Law Firm, PLC. Patrick began his legal career practicing real estate, construction, and general business litigation.
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