Business Planning and Formation
There are a number of factors that must be considered when deciding which entity to use for operating a business. These factors include tax, legal, and operating considerations.
Although it is possible to form a business through incorporation services like LegalZoom, it is important to remember that incorporation services do not provide legal advice and cannot provide their customers with legal analysis or advice on the important entity selection issues that each start-up company faces.
This advice and analysis can only be provided by a competent business law attorney. I provide my clients with this advice and analysis and also help my clients with preparing and filing the paperwork necessary to form and organize a Michigan business entity.
The following is a discussion of the various ways to legally organize and operate a business in Michigan.
If your business will have just you as the owner, you could operate as a sole proprietorship. Although it is very easy to get started as a sole proprietorship, these days it is as outdated as a Commodore 64. Those who work as sole proprietors have no legal liability protection and all income will be reported on their personal income tax returns, subject to self employment and regular income tax. In most cases, you should do yourself a favor and pass on this way of doing business.
Single-Member Limited Liability Company (LLC)
The single-member LLC is a great alternative to operating your business a sole proprietorship. On the surface, this type of entity will appear to be a sole proprietorship, but it will have the legal protection offered by the formation of the LLC. To form a single member LLC by filing articles of organization, you must file articles of organization with the state. Business formalities are minimal; you don't even need to have an operating agreement (although in some cases it would be advisable).
A regular LLC – as opposed to a single member LLC – is formed by two or more people. This is an entity that combines the tax advantages of a partnership with the legal liability protection of a corporation. An LLC offers many different options for structuring your business, and is particularly effective for real estate projects. Due to its flexibility, the LLC has become a popular choice in the past few years. However, an LLC is not suitable for all businesses. Self employment tax on the profit may apply if you are an active member and no members can take wages. If you are considering an LLC for your business, it is vital that you consult with your attorney to confirm that it would be an appropriate entity for your particular situation.
A C corporation is a separate taxable entity subject to federal and state income tax. Most of the major businesses you hear about in the news are C corporations. If you form your business as a C corporation, your company will pay tax, and any profits distributed to you will be taxed again on your personal income tax return. In spite of the double taxation issue, C corporations can provide good tax planning opportunities and may also have more employee benefits options available than other types of business entities. C corporations are also the preferred type of entity if you are contemplating soliciting venture capital for your company or taking your company public.
The S corporation has a tax structure similar to an LLC, but the legal structure of a corporation. The S corporation is formed with the state the same as a C corporation, but there is an additional step. You (and any other shareholders) must file an election with the IRS to be treated as an S Corporation for tax purposes. There will be no double taxation; all income will be passed to you on your personal income tax return. Before LLC’s were available, S corporations were generally the entity of choice for small (and even some mid size) businesses. There a number of restrictions on who can be shareholders in an S corporation (as well as a limit on the total number of shareholders), so you should check with your attorney to determine if this type of entity would be appropriate for your particular situation.
The choice of which business entity to use is one of the most important items to consider as you take the necessary steps to start your new business. Please feel free to contact Michigan business attorney Michael J. Hamblin for more information on how he can help you with your legal needs.