Investing your money in order to accumulate wealth over time is an excellent idea. But is it best to simply do so as yourself or are other business entities useful for investing? For that matter what are the options when it comes to business entities? Which ones best fit your personal investing needs?
Business Entities
Business entity options include being a sole proprietor, having a limited liability company, having a limited liability partnership, or forming a C corporation. There are pros and cons to each of these options.
Sole Proprietor
Most folks who start a business do so without setting up a special entity. They are sole proprietors. This business entity requires no work to set up as it the default, easy to operate, has no double taxation issues, and is the best fit for a business intended to operate only for the life of the owner and one with little potential liability. A significant problem with being a sole proprietor is that if your business runs the risk of being sued for actions that can be tracked back to you, you are personally liable for your business and may lose personal assets like your home in amounts far in excess of what you have invested in or gained from your business. Limited liabilities companies are designed to help protect your personal life from problems of your business.
Limited Liability Company
Although an LLC or limited liability company is not the default business entity it is easy to have one set up for you. Such an entity is simple to operate and does not require a separate tax return. Home deductions on taxes can be taken with an LLC. An LLC can also be easily dissolved when you no longer need it. The main purpose of a limited liability company is to protect your personal finances from problems in your business. With an LLC business problems, except for malpractice, will not spill over into your personal financial life. Four issues to consider are that self-employment taxes are assessed on all profit with an LLC, transferring ownership can be complicated, an LLC does not offer much in terms of fringe benefits for owners, and you will need to make sure to document all aspects of your business showing that it is totally separate from your personal finances! Not following this last step can result in losing LLC protection just when you need it.
C Corporation
A C corporation is a standard stock corporation where stock holders who have not hand in managing the business are totally separate from the business in Drawbacks of a C corporation are the double taxation of profits. complexity is setting up the corporation, and the need for both regular and documented director meetings and two tax returns instead of one.
Which Business Entity Is Best for Your Investing?
If your “day job” is your own business and not a job working for someone else, you may wish to consider an entity different from being a sole proprietor. This may especially be true if you have substantial investments and investment income as well as a personal business the carries large potential risk. Medical and legal professionals come to mind as those with a healthy income stream, growing investment income and the potential for being sued for large amounts of money. Individuals who have inherited substantial wealth need also to be careful in taking on risk from owning and managing an outside business with potential and substantial risk. To the extent that someone has joined a business partnership meant to supplement their investment income, choosing an LLC partnership can be an excellent idea. With such a setup the liability of a partner is limited to their investment in the partnership. Like with a single owner LLC, it is crucial that records are kept making a clear the limit of a partner’s involvement in partnership management and strict separation of business and personal finances in order not to lose LLC protection just when it is needed most.
