Why Should I Form an Entity?

Why Should I Form an Entity?Photo by Christina Morillo

Originally Posted On: https://www.wyoming.llc/blog/why-should-i-form-an-entity

 

It seems that everyone you talk to these days is a member, partner or shareholder of at least one entity. This is because every year, tens of thousands of corporations, limited liability companies (LLCs) and limited partnerships (LPs) are formed in the United States. Why is everyone so entity-happy these days? Individual reasons can vary, but there are four main reasons to form an entity.

1. Asset Protection

The best way to protect your assets is to separate them from each other and form yourself. The limited liability concept arose in the 1500s as a means of encouraging individuals to invest in maritime ventures. Before the establishment of corporations, investors in a ship that was lost at sea not only lost their investment, they were financially ruined. Creditors of the venture could personally sue the investors. The English Crown had the foresight to limit the exposure of investors through the corporate charter. As a fictitious entity created and chartered by the Crown, a corporation became a creature separate from its owners and employees.

As such, the corporation’s debts were not extended to investors, providing investors the protection of limited liability. By allowing a group of investors to safely pool their resources in a corporation, the Crown enabled voyagers to explore the seas and seek profit without the fear of losing everything. With the addition of a few new limited liability vehicles, governments today continue to allow those willing to risk money in economic activity to limit their exposure.

The United States is the most litigious society in the world. But even outside of the United States, looking over your shoulder all the time is no way to live. The best way to avoid losing your hard won assets is to shield them from each other. Placing your business and your assets into limited liability entities protects them from exposure to each other.

Imagine that there was a shoebox available that held potential liability rather than shoes. By purchasing and maintaining these shoeboxes, your personal assets would be safe from the threat of a suit arising from your business ventures and investments. All liability associated with the investment or venture would be stuck within the six walls of the shoebox. Imagine further that each of these shoeboxes were very affordable to purchase and maintain.

So you may be a shareholder or possibly a limited partner, director, officer or manager of an entity, but you are not the entity. So long as you always respect your entity as something separate and apart from yourself and follow the rules, you and yours will remain separate and distinct – i.e. limited in liability. Limited to what? Your ownership interest. That’s it.

Asset protection is achieved through the use of entities. And Wyoming LLCs offer the best asset protection laws in the nation.

2. Tax Incentives and Fringe Benefits

In most forms of ownership, you and your business are one entity for income tax purposes. By contrast, if you form an entity separate from yourself, you have a choice of tax treatment. Be aware that entity selection can enable you to minimize taxes in the following ways:

  • If you are taxed as a corporation you can decide when to distribute dividend income. For instance, if you’ve had a good monetary year in other aspects of your financial life, you may choose to hold on to some of the corporate profit at the corporate level.

  • Profits, other than salary, taken out of an S Corporation are not subject to payroll taxes.

  • Medical insurance for you and your family may be fully deductible with C Corporation taxation.

  • Retirement plans may be set up using pre-tax dollars.

  • Losses are fully deductible for a corporation whereas an individual must prove a profit motive before deducting losses.

  • Different levels of estate planning can be accomplished through entity selection. Limited partnerships in particular are great tools for estate planning because the IRS actually allows you to reduce the taxable amount gifted to Limited Partners.

  • If you are taxed as a C Corporation you can choose your fiscal year, for example, June 1st or October 1st instead of January 1st. Not being hemmed into a calendar year allows for some creative tax planning. You may also use accounting methods that are best suited to your needs.

  • Single member LLCs are disregarded entities for tax purposes; thus an LLC that owns real estate can still gain the tax benefits of sole ownership while, in most states, enjoying limited liability status.

  • So long as certain treasury requirements are met, and LLC can make special allocations of profits and losses among its members.

  • Property contributions to an LLC by members are not taxable events.

  • LLCs may increase their asset basis if a member’s interest is purchased.

  • LLCs can distribute certain property to their members tax free.

3. Perpetuity

Because you are creating an entity that exists apart from you, it can live forever. So if a corporate founder passes away, business can go on as usual. Even with LLCs and LPs you can be sure that there won’t be a break in stride through a properly written Operating Agreement or Limited Partnership Agreement. This continuity of existence and its natural extension of ease of transferability are other bonuses associated with entity formation.  An entity’s assets and accounts may be transferred by an assignment of stock or membership/partnership interest. With a sole proprietorship, each individual asset, license, permit, etc. must be transferred individually. And unlike a corporation, LLC or LP, when the sole proprietor dies, the sole proprietorship dies with him or her, offering no business continuity.

4. Privacy

If you are well known as an individual with some backing, in a profession where people automatically assume that you have deep pockets, or if you are an easy target for a lawsuit, then privacy is essential. There are many sources of information available to the want-to-be litigant. The less your name appears on public records, the greater the chance that you will be left alone. Entity formation allows a measure of privacy because the name of your entity, not your own, is used. Through the use of a nominee officer, director, or manager, you can achieve a much greater level of privacy in that the nominee’s name, and not yours, appears on all state filings and on the internet.

Wyoming is one of the few states that does not list your name on the Secretary of State’s website, which is another reason why it is an excellent state for asset protection. The less information people can find out about you, the better off you are.

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