Setting up a New Jersey business: choice of legal entity

New Jersey law offers several types of legal entities for businesses.

With the economy picking up at a slow but mostly steady pace, New Jerseyans may be establishing new businesses. One of the first decisions the new business owner will need to make is which type of business entity makes the most sense, considering the goals of the entrepreneur.

Legal counsel to business creators

As a first step, it is wise to find a New Jersey business attorney with experience in setting up new businesses in the state. Legal counsel can educate the businessperson from the beginning about the decisions the owner must make when creating the business venture. A knowledgeable commercial law attorney like one from Dunn Lambert, LLC, in Paramus (and New York City) can answer questions and provide advice to help the owner determine the most advantageous type of entity for the business.

Important considerations in business entity choice

The legalities of creating a business entity are mostly controlled by state law, and New Jersey offers several different options. While many aspects of the business are impacted by entity choice, the following three considerations are most important for most business owners:

• Liability: Will the owner’s personal assets be at risk for business debts and liabilities or will the owner’s personal assets be insulated from claims of creditors?
• Taxation: Will the income (or loss) of the business be passed through to the owner’s individual tax return, or will the business be a separate tax-paying entity?
• Control and management: Will the owner keep the power to manage the business, or will management decision-making be shared with or delegated to others?

New Jersey business entities

The sole proprietorship is the simplest type of business structure, because the owner-entrepreneur and the business itself are one, and no separate business entity is created. The owner contributes and owns the business assets, manages the business and is personally liable for the debts and obligations of the business. The business income is considered personal income of the owner and is reported on the owner’s individual income tax returns. Although it is the simplest form of entity, it is rarely advisable, since the business owner’s assets are exposed to claims of creditors of the business.

A general partnership is the association of two or more owners to create a business for profit. Like the sole proprietorship, income (or loss) is passed through to the partners’ individual tax returns. While there are few legal formalities to establishing a partnership, it can be advantageous for the partners to execute a partnership agreement that governs legal aspects of the business.

Without a written partnership agreement, New Jersey law will control certain legalities in the partnership business. For example, unless an agreement says otherwise, management is shared equally among the partners, and each partner can bind the partnership (and thereby the other partners) in contract. The major disadvantage of the partnership is that each partner is personally liable for all debts and obligations of the partnership. For this reason, it is generally not advisable to do business in a general partnership.

To conduct the business, the business owner may choose to set up a corporation, a separate legal entity that comes into existence on the filing of a Certificate of Incorporation with the New Jersey Department of Treasury. The corporation is owned by shareholders who buy stock in the company, and the business is run by its board of directors, who elect officers. The most important reason to establish a corporation is that, as a general rule, the shareholders are not personally liable for the debts and obligations of the corporation.

For tax purposes, corporations are either regular corporations, referred to as “C” corporations, or “S” corporations. In order to qualify for “S” corporation treatment, the owner must meet strict requirements and file an “S” election on Form 2553. “C” corporations are subject to two levels of taxes: once at the corporate level and again when the corporation makes distributions to its shareholders.

“S” corporations escape double taxation since they operate as pass-through entities. The “S” corporation generally pays no tax on its income; the shareholders are taxed at their individual rates on the corporation’s income. The “S” corporation combines the best features of the corporation (limited liability) and the partnership (one level of taxation).

The “S” election deserves careful consideration and consultation with the business owner’s accountant. “S” corporation status may be very beneficial if it’s expected that the business will incur losses in the early years or if the owner is expected to be in the lower individual tax brackets for a while.

A limited liability company (“LLC”) is a relatively new type of business entity that combines features of a corporation and a partnership.

Here is a comparison of the LLC with the S corporation – the entity with which it is most often compared:

1. Both LLCs and S corporations offer pass-through taxation at the federal level.
2. Both LLCs and S corporations afford members/shareholders insulation against liability for the debts and obligations of the entity.
3. However, S corporations are subject to a number of tax rules that do not apply to LLCs:

S corporations may issue only one class of common stock and no preferred stock. LLCs can have flexible capital structures.

S corporations cannot have more than 75 shareholders. LLCs may have an unlimited number of members.

Effective January 1, 1997, S corporations are permitted to be 100 percent shareholders of other S corporations. However, a “C” corporation cannot own stock in an S corporation. S corporations may not have “non-U.S. persons” as shareholders. In contrast, LLCs may have U.S. citizens or foreign persons, and U.S. corporations and foreign corporations as members.

S corporations must properly complete and timely file various tax forms. LLCs have no such filing requirements.

How do you know if an LLC is right for your business?

1. The LLC provides the same limitation on personal liability and pass-through tax treatment as an S corporation, without the need for various S corporation tax filings and compliance with the man y tax rules that apply to S corporations.
2. Avoidance of the need for a board of directors. All members of an LLC can participate directly in the management of the company, without the need for a board of directors.
3. The combination of limited liability, pass-through taxation, relaxed rules for non-U.S. investors, and flexibility in capital structures make the LLC the vehicle of choice for many new business start-ups.

A knowledgeable New Jersey business law attorney can provide the advice and guidance needed for a New Jerseyan to make the important decision of which business entity to choose.

Keywords: New Jersey, legal entity, business, choice, taxation, decision, consideration, liability, management, control, sole proprietorship, partnership, limited liability company, LLC, corporation, C corporation, S corporation