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General Considerations

 A business venture can be structured in several ways; however, the law classifies businesses so that most fall into one of three forms- the sole proprietorship, the partnership, or the corporation.  There are also certain variations on some of these basic legal forms, such as the C Corporation, S corporation and the limited liability company (LLC).

If you are planning to start a business, consider the following questions when deciding your business’ legal form:

  • Will someone else share in ownership of the business? If so, it will not be a sole proprietorship.  The choice will be between a partnership arrangement and a corporation, or possibly a limited liability company.
  • How important is it to limit personal liability for debts or claims against the business?  If this is a major consideration, incorporating the business would generally be the best means of limiting your liability.
  • Which form of business organization will result in the least taxes?

     

Before choosing the legal form of your business, it is important to realize that you may need to change to a different form at some time in the future.  Changing legal forms is easier to do with some forms of business than with others.  As a broad generalization, it is usually a simpler matter to change from a sole proprietorship or partnership to a corporation, than it is to move in the opposite direction.

For example, converting a corporation into a sole proprietorship or partnership may result in substantial individual and corporate level taxes when the corporation is liquidated.  This would occur if the value of the business, when transferred to the stockholders of the corporation, was greater than the cost or tax basis for their stock, resulting in taxable gains to the stockholders.  If some of the corporate assets have value in excess of their tax basis, the corporation will also have taxable gains and will pay a corporate tax on such gains when it transfers the assets to its stockholders.

While there are almost always some expenses and complications in changing the legal form of a business, such changes are quite routine transactions.  Many businesses start off as sole proprietorships, develop into partnerships, and later incorporate, if tax and other considerations indicate that it no longer makes good business sense not to be incorporated.  Thus, the choice of one legal form when starting a business should not be considered a final choice.


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