What is a Legal Entity?

Dear M & M: I am trying to start a company and I am being told I need to determine what legal entity I want to be. I don’t understand. What is a legal entity? – James

Dear James:

Becoming a legal entity is one of the first decisions a business owner must make when forming a company or an organization. Generally speaking, there are three basic types of legal entities in which business can be conducted: (

1) sole proprietorship, (2) partnership, and (3) corporation.

Within each category, there are several variations. Determining which form is best for a particular commercial enterprise depends on a variety of considerations, including the number of owners, acceptable liability of owners, tax treatment, transferability of ownership interests, set-up costs, and other factors.

A legal entity determines what your legal rights and responsibilities to enter contracts are and what responsibilities you as the owner has to pay debts or fulfill obligations on behalf of the organization. There are three things to consider when forming a legal entity. The first is the cost to maintain and become.

Each legal entity has considerations in time, money and ongoing compliance to maintain your status or to be in good standing. A second consideration is your legal obligation to settle debts and risking your personal assets. Insurances can be purchased, but each legal entity has various layers of protection and responsibility.

Finally, as each type of legal entity is taxed differently depending on your unique situation one should consider the tax consequences of each type of legal entity. One can see that you should seek professional advice from a competent attorney to help you better understand liability and protection against lawsuits.

Do not forget the tax side of this choice in determining what legal entity you will become. A second person that needs to be contacted to help you decide what legal entity is best for you is a tax attorney competent in this area. Remember, each legal entity is taxed differently. As a business owner you need to consider the tax consequences of what legal entity you have chosen to operate as.

Remember as a legal entity, the organization or individual has the capacity to: enter into contractual relationships with other legal entities, sue others for failing to uphold contractual duties and file taxes. On the other hand, a legal entity also holds corresponding legal responsibilities.

For example, a legal entity is liable performing contract terms for any violations that were done in the company name. Although the legal entity can be sued for violations done by the company, the individual members might not be liable for company violations.

This is one of the main features of a legal entity, and a main reason why people would choose to form a certain legal entity rather than operate independently (i.e., to have insulation or buffering from legal liability). Of course, the exact details regarding liability will be different for each business form.

Also, there are some instances where individuals might be held liable even if the violation involves the overall business (for instance, if they acted independently from the company’s instructions).

Remember, it isn’t just only about protection against possible lawsuits there is a tax consideration, costs to become and maintain. Each legal entity has different guidelines that need to be done to maintain a legal entity from filing annual reports to maintaining company records. Source: Legal Match



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