Setting up a legal Entity for A small, privately held business is one of the smartest decisions a business owner can make. Done correctly with proper initial strategies and disciplined ongoing formalities a small business owner can maximize profits, protection, privacy and tax advantages. Business Legal Entity types are typically Corporations, LLCs and sometimes Limited Partnerships.

These small business advantages are often better than large public companies and almost always better than being employed by someone else. That is one of the reasons there have been numerous articles written stating that if someone thinks they are really good at a certain specialty then forget looking for a job and start your own company providing that service as an outsource vendor. 

Once decided to start a business, or if one is already up and running, then the decision of Incorporating and what type of Legal Entity and taxation election are paramount. Without a Legal Entity a company is automatically designated as a Fictitious Business (DBA) of the owner without a protective legal veil and less favorable tax advantages. This means the owner is personally liable for any legal or tax challenge.

Just about everyone follows the money (tax advantages and profits) as it is the necessary goal; however, protection has to be the top priority when incorporating. The money will come but so will problems and the money and the owner have to be protected. Remember, if you lose the “Goose that lays the Golden Egg” there may not be any money or opportunity but very well may be heavy personal obligation. 

Guidelines: Once the Incorporation decision is made, the following guidelines may be very helpful.

• Use a Fulfillment Incorporator. A fulfillment company assists the owner in all facets of strategy and compliance. They practically do everything for their clients concerning the corporate structure. They are the antithesis of the “Cheap” self-help incorporation kits often promoted on the internet and late night TV. FYI: NO, you cannot incorporate completely and correctly for $100.00 as some offers suggest.
• Entity Types. The typical options for a small business are a Corporation, LLC or Limited Partnership and have protection and favorable tax elections. Note: General Partnerships are typically not a Legal Entity although Legal Entities may form a General Partnership. 
• Corporations. Corporations are the best known as they have been around for centuries. They are owned by Stockholders, managed by Directors by resolution and run by Officers. Of the four (4) available tax elections they are limited to “C” elections and “S” elections. In some instances, there may be compelling reasons to use corporations. FYI: Nevada is the only known state to offer Charging Order Protection for Corporate Stockholders.
• LLC. Limited Liability Companies are becoming increasingly popular for several different reasons. One reason is simplicity. However, there is a caveat for this simplicity. The typical simple form of LLC is Member Managed and can expose the owners. If using professional assistance, such as a Fulfillment Company, it is better to use the Manager managed LLC where the owner(s) are kept private and have the Operating Agreement run the LLC internally where ownership is segregated from operations. A specifically designed Manager managed LLC, when an option, is typically the superior Entity to use. Plus, it has access to all four (4) tax elections.
• Limited Partnership. These are used primarily to raise funds and give the investors limited liability and passive income. They are a favorite of many real estate developers. Investors, being either legal or natural persons, are typically treated as Entities Disregarded for tax purposes.

Available Business Tax Elections (4)

• “C” tax elections are typically used for larger and/or publically traded companies, which pay profits to Stockholders as Dividends. Stockholders only pay income tax, on the dividends and not employment tax as it is a return on investment. However that creates “double taxation” as Dividends come from profit that has already been taxed at the Corporate Level.
  
  >Interesting Political Note: The current Presidential campaign has been spotlighting Romney paying less tax than a middle income employee’s higher rate. This misleading comparison is not equitable as it compares Investment Dividend rate and an employee’s rate which includes FICA. Additionally, the Investment Dividend may create as much tax secondary to “Double Taxation” and high wage earners may pay higher tax amounts on employment income than someone earning $50,000.00 a year. For the purposes of this discussion it shows how the IRS and state tax code(s) can favor the person using a Legal Entity Vs employee or sole proprietor; even more so with the “S” election for small businesses.
  
  
• “S” elections are typically more beneficial for business as the profit is paid to Stockholders as a Passive Distribution (no FICA or Double Taxation) which grants a very favorable tax election while providing protection. Plus, profit can often be greater than wages. To see a tax savings comparison go to corporatenevada.com and use the tax calculator. “S” elections are limited to 100 owners and must be US citizens or resident aliens with a Social Security number.
• Partnership Election. This election is used by Limited Partnerships and sometimes LLCs when the owners are employed elsewhere and are doing a separate venture together. With this election, profit flows to the owners as passive income and is shown as a schedule on the owner’s income tax return.
• Entity Disregarded. This election, commonly called a Disregarded Entity, works the same as the Partnership Election but is for only one owner. It also a schedule on the owner’s return.

In summary, Incorporating is always the most beneficial option. Not only does it provide the best protection it maximizes profit, privacy and tax advantages for a business and owner(s).

As a consultant for Corporate Nevada, contributing author Jay Ray has over 40 years experience assisting thousands of clients worldwide with their corporate business strategies, including incorporation and LLC formation, asset protection and tax liability.