August, 2006 Tax Newsletter

Is Your Business in the Right Entity?

From a tax, legal, and asset protection standpoint, a critical decision to make when starting up a business is the type of entity structure it should operate under. This is clearly not a one size fits all, but depends upon the nature of the business. For example, if your business will purchase or hold appreciating assets such as real estate, you need a business structure that provides the best blend of asset protection and tax-savings advantages. A C corporation would not be a good choice, as it is taxed separately and you will wind up paying tax on any profits twice, once when the corporation sells the asset and realizes a profit, and again when you take that profit (less the taxes paid on it) out of the corporation, because you must pay tax on that profit again on your personal return.

If you are looking to form an asset-holding business you would want to use a limited liability company (LLC) or a limited partnership (LP). These two structures offer an excellent blend of tax savings and legal protection.? Because they aren't taxed at the corporate level you will only wind up paying taxes on the sale of assets once, at your personal level. They are great choices from an asset protection standpoint too, because under most state laws including Arizona and California), your ownership interests in either an LLC or an LP can't be seized and sold by a creditor. So, if are sued for something and lose and have a judgment against you, all of the assets held in your LLC or LP remain safe from seizure by that judgment creditor. This advantage is the most valuable aspect of these two entities, outweighing even the tax savings that they offer.

I have many clients with S corporation mentalities that want to hold appreciating assets in S corporations. Their reasoning is that it offers the same flow-through taxation benefits as LLCs and LPs.  While an S corporation is generally similar from a tax standpoint, it isn't from a legal one. While your ownership interests in an LLC or LP can be protected from a creditor, this is not true for your ownership shares in either a C or an S corporation. Your shares in either of these entities can be seized by a judgment creditor, meaning that if you can't otherwise pay off a judgment against you a creditor can seize your shares and, through them, all of the assets in that C or S corporation. This is why one should not consider holding appreciating assets in a corporation. An LLC can elect for tax purposes to be a corporation.  In general, this affects only the tax, not the legal aspects.

I would be happy to discuss the appropriate entity for your business so that you can achieve the best tax results and, at the same time, keep it out of harm's way.