As a company or business owner, one of the most important decisions you’ll have is choosing the best legal structure for your company. This choice will have far-reaching effects on liability protection, tax considerations, and operational flexibility.

Trusts and limited liability organizations (LLCs) are two common and frequently considered solutions. Each has unique advantages and nuances that must be carefully considered to align with your business objectives and needs.

Although choosing the right entity won’t ensure success, choosing the wrong entity can prove expensive. Because each of these business types has advantages or disadvantages for the taxpayer, the practitioner can give important advice on this selection.

This article aims to address questions regarding the advantages and disadvantages of using different types of ownership when starting a new business. It is important to identify the features of various types of ownership.

So, Let’s get started!

Why is Choosing a Business Entity Structure Important?

A business entity is the legal and organizational framework that a person or group creates for their business. Entity structures differ in terms of responsibility, transferability, cost, taxes, and simplicity. Choosing your business’s structure is one of the most essential decisions you can make when beginning your company since it influences business decisions, tax efficiency, and your potential to expand.

Types of Business Entities

There are four types of business entities: corporations, partnerships, limited liability companies, and sole proprietorships.

1. Corporation

A corporation is a legal entity apart from its owners. It may profit, be taxed, and be held legally accountable. C-corporations, S-corporations, and B-corporations are among the most common corporate structures.

Pros

• Provides the highest protection against personal responsibility for its owners.
• Easily transferable
• Can raise cash through the sale of stocks.

Cons

• More costly to build than other structures.
• Comprehensive record-keeping, operating procedures, and reporting
• Pay income tax on their earnings, which means companies are taxed twice: once on profits and again on the personal tax returns of shareholders receiving dividends.

2. Partnerships

Partnerships are basic business structures formed between two or more persons. It is legally and financially distinct from its owners. There are two major forms of partnerships: general partnerships and restricted partnerships. There are various sorts of partnerships, however some are not legal in all jurisdictions or only apply to specific professions or situations.

Unless otherwise specified in a partnership agreement, each partner bears full liability and all partners are equal.

A limited partnership is approved by the state and is made up of one general partner who is accountable and one or more limited partners who only give money. Limited partners are only responsible for their investment in the business, which protects their assets.

Pros

• Easier and less costly to establish than a company.
• Pass-through taxation results in fewer taxes.
• Simple entity structure to test a business idea before creating it more officially.
• Legal and financial obligations are borne equally among general partners.

Cons

• Partners are answerable for one another’s decisions.
• General partners risk their assets.
• An entity can dissolve after the death or bankruptcy of a partner.
• Limited capacity to raise funds.

3. Limited Liability Company

A limited liability company (LLC) is a business structure that combines the characteristics of a partnership and a corporation. It enables members to take benefit of pass-through taxation while protecting them from personal legal accountability.

Pros

• Protection from personal responsibility.
• Pass-through taxes involve avoiding double taxation.
• Simple legal requirements.

Cons

• Limited ability to raise funds without stock options.
• Different restrictions are based on the state.
• The company would dissolve upon the death of a member.
• Transferring ownership may be difficult.

4. Sole proprietorship

A sole proprietorship offers you entire control over your business, but it does not create a new corporate organisation. This is the most common corporate entity structure. For example, Marketinglad, a B2B marketing agency that offers a comprehensive range of digital marketing services to help businesses achieve their marketing goals.

Pros

• Easy to form.
• The owner has full control of the business.
• Ideal for testing a business before incorporation.

Cons

• Personal responsibility.
• Difficult to raise finance
• Banks are unable to provide them to these firms.

How do I Choose the Right Entity Structure for my Business?

Choosing an entity is an important choice. Here are the objectives to consider while selecting a business type.

1.   Tax Savings

The tax costs of running a new or existing business can often be a key issue for its owners. The right entity type can reduce both self-employment and income taxes. Understanding the complete tax position, including corporate and personal income taxes, payroll taxes, and estate tax exposure, plays an important role in determining the appropriate entity option.

2.   Limitation of liability

The primary goal of some people is to protect themselves from responsibility. The owners/partners aren’t restricted in responsibility under the proprietorship or general partnership classifications. Limited partnerships, limited liability companies, limited liability partnerships, S corporations, and C corporations may provide liability protection to partners/shareholders depending on the owners’ involvement in business activities, employee involvement, lender requirements for personal guarantees, and the application of professional service malpractice statutes. An owner may still be held accountable for criminal conduct carried out on behalf of a limited liability corporation.

3.   Management

One of the most prevalent reasons for an entrepreneur to establish a business is the ability to make major decisions. The degree to which one individual may make all choices, or how decision-making responsibilities are distributed among a group, is determined by the business’s ownership structure.

If more than one person holds equity in a business, it cannot be operated as a sole proprietorship. If all owners agree to give management services, a limited partnership is not an option since limited partners cannot supply management services without jeopardizing their limited partnership status. Other companies limit the responsibility of management-level owners.

4.   Motivation

Most new entrepreneurs have diverse motives for starting and running their firms. Some people want to establish a business that will become big enough to have an IPO and be traded on a national stock exchange. These business owners may choose an entity that facilitates the transition from a private to a public firm or the process of acquiring external funding.

5.   Ownership Transfer

In many circumstances, a change in entity status serves to complete a transfer of ownership. Whether the purpose is to transfer ownership to a successor via gifts, installment sale, stock redemption, bequest, or a mix of ways, it is sometimes required to use a different form of business to achieve client objectives.

Business Trusts vs LLC: What is the Difference?

Trusts are often associated with inheritance planning, but they may also be used for commercial operations. As a small business owner, you can keep the business in a trust rather than becoming a limited liability company (LLC) or corporation.

The majority of business owners carry out their businesses through a corporation or a limited liability company (LLC). Corporations and LLCs are excellent business solutions because they have limited liability and are distinct from their owners. Business trusts, while less well-known, are still an excellent alternative.

While business trusts have the same confined liability and function as independent companies to conduct business, they differ significantly in three ways: they give more privacy, require less compliance, and are an effective estate planning tool.

Trust Basics

We’ve all heard of trusts, but most likely just in the realm of estate planning. Nonetheless, these “estate trusts” have basic similarities with business trusts that help us understand company trusts. Trusts are formed up of four things:

• A grantor,
• A trustee,
• Property, and
• Beneficiaries

These four parts interact in a trust agreement, often known as a “declaration of trust,” which is a legally binding document outlining a trustee’s duties and obligations concerning to trust property and beneficiaries. The declaration of trust governs the management, investment, and distribution of trust property, as well as the trust’s termination and final distribution of assets. The same things happen in a business trust.

However, a business trust exists only to carry on a business. On the other hand, while estate trusts retain a variety of income-generating assets (such as stock, real estate, bonds, and so on), they are not mainly founded for commercial objectives. So, let’s look at how to establish a business trust.

Business Trusts

In business, ‘trust’ refers to the confidence and reliability that exists between entities in economic interactions. It is essential for effective collaboration, consumer loyalty, and ethical business practices. Unlike the formal trust structure, which works without conventional owners for the benefit of beneficiaries, trust in business is about building and maintaining strong, dependable relationships.

Business trusts, like corporations and LLCs, but unlike estate trusts, are formed to run a business. Also, while a business trust could have interests in another company, this should not be the exclusive aim of the trust.

Operation of a Business Trust

What does it mean to set up a business trust to administer the business you run? Let’s begin with what a business trust should possess. At the most basic level, a business trust should hold its operational bank account and all commercial contracts. After that, you may decide what else your company trust should possess. However, you could think about keeping cars and equipment out of the business trust’s name. As an alternative, the business trust may own the corporation that holds these assets. The crucial thing is that this option is entirely dependent on how you wish to handle trust risk.

The trustee is in charge of running the business daily. They may transfer some of these responsibilities to officers or staff of the company trust. However, the trustee runs the business in the same manner that a corporation’s president or an LLC’s manager would.

Pros and Cons of a Business Trust

Depending on the type of trust established, business trusts may have the following benefits over some typical business structures:

• Avoidance of probate after the death of the business owner
• Reduced or eliminated inheritance taxes
• Business continuation when the owner dies or becomes disabled
• Separation of business and personal assets (similar to an LLC)
• A business trust provides greater privacy than an LLC since no public filings are required.
• Protecting assets from creditors
• Simpler formation method compared to some typical business forms.

Business trusts may also have the following complications:

• Ongoing costs to maintain the trust (for example, hiring a third party to administer it).
• Challenging legal rules (for example, the IRS does not recognize a business trust as a sort of business organization).
• The fiduciary connection between the trustee and the beneficiaries compels the former to behave in the best interests of the latter, which may differ from the obligations needed in a standard corporate structure.

LLC

An LLC is formed by filing documentation, including a certificate of formation, with the secretary of state in the state where the firm will be legally located. It is one of the most prevalent forms of business entity, alongside sole proprietorship, partnership, and corporation.

An LLC is a legal entity that exists independently from its owners. This implies that the owner’s assets are protected from creditors if the company incurs debt and fails to repay it. Similarly, if the business is obliged to pay monetary damages as a result of a lawsuit, the payment must be made from the corporate assets, while the owners’ assets are secured.

Pros and Cons of LLC

LLCs have a simpler management structure than ordinary corporations. They also avoid double taxation on corporate profits by distributing dividends directly to their owners, who pay income taxes at their rates.

LLCs can also help transfer corporate assets to heirs. In many states, an LLC-organized firm can be passed down to the next generation without the time-consuming probate process. In addition to commercial assets, LLC owners can include other types of assets in the entity, allowing more of their estate to avoid probate.

Other benefits of LLCs for investment property owners include:

• Single-member LLCs are not required to submit a federal tax return.
• LLCs may use 1031 exchanges.
• The LLC is the plaintiff in the eviction proceedings.

There are a few drawbacks to forming an LLC, but in many cases, the benefits exceed the cons.

• An LLC often costs more to set up and maintain than a sole proprietorship or general partnership. States require an initial formation fee. Many states also charge recurring costs, such as yearly reports and franchise tax payments.

• Ownership in an LLC is sometimes more difficult to transfer than in a corporation. Corporations can sell shares of stock to expand ownership, and individuals can sell their shares to others unless there is a shareholder agreement that prohibits it. Unless the members agree differently, adding new members or changing existing members’ ownership percentages is typically approved by all members of an LLC.

What are the LLC Articles of Organisation?

Although it is common to hear of an LLC being “incorporated,” the proper method to characterize the formation of an LLC (or any organization type other than a corporation) is to state it has been “formed” or “organized.” The terms “incorporation” and “Articles of Incorporation” refer to a corporation (whether it is taxed as a C corporation or a S corporation).

While each state’s LLC creation document differs in various ways, there are a few comparable components. This includes the following:

• Name, primary location, and purpose of the business
• The registered agent’s name and physical address
• Whether the LLC will be controlled by its members or its managers

Each state typically provides standard forms for an LLC’s articles of organization. The individual who founded the LLC must sign the documents. In most circumstances, it is not necessary to be a member or manager. In certain states, the registered agent’s agreement to serve as a registered agent is also necessary.

Once authorized and submitted, the state will provide a certificate or other confirmation document. The certificate acts as legal confirmation of the LLC’s status and may be used to create a company bank account, apply for an EIN, and so on. Some states may additionally require you to issue a notice, often in a local newspaper, certifying the creation of the LLC.

Business Trusts vs LLC

Here are a few differences between business trusts and LLCs: Business trusts vs LLCs.

Protection: LLCs are better at protecting business assets from creditors and legal action. Trusts may handle a variety of assets and are more effective at avoiding probate and lowering estate taxes.

Cost: LLCs usually have greater recurring fees than trusts.

Privacy: Trusts are completely private, whereas LLCs are public records.

Maintenance: Trusts are reasonably straightforward to set up and require minimal maintenance.

Control: If you want to preserve control of your assets while still protecting yourself from responsibility, then an LLC may be the best solution.

Now, Business trusts vs LLC which is better? In some situations, creating both a trust and an LLC helps manage your entire estate.

Conclusion

Whether you select a corporation, a partnership, a limited liability company, or another organization, you should carefully evaluate each of these aspects. Once in place, changing entities is possible, but complicated.

You must pick the right business organization for your needs. Consider how it will impact your business, money, and legal exposure. When deciding on a business entity, ensure that your tax legal counsel and corporate lawyer agree.