The initial and most important decision facing a new business owner is a task often referred to as “choice of entity" -- whether to operate the endeavor as an LLC, a partnership or a corporation.

However, it is important to understand that choice of entity requires three types of analyses, each of which is entirely different from the others. When considering choice-of-entity, owners should do all three analyses and then, if there are any conflicts among them, reconcile these conflicts.  The three issues to be considered are:

• Non-Tax Considerations. The first type of choice-of-entity analysis is non-tax choice of entity. This is the process by which lawyers choose the best type of business organization for their clients on non-tax grounds—mainly on business organization law grounds. The key types of business organizations are sole proprietorships, general partnerships, limited partnerships, corporations and LLCs. The most common issues include (1) determining the optimal form for personal liability protection; (2) the level of management participation desired by each owner; and (3) the need for special statutory business asset protections referred to as charging order protections;

• Federal Income Tax Considerations. The second is choice of federal income tax regimen for federal income tax purposes. The relevant regimens are disregarded entity taxation and Subchapters C, K and S. Key issues include: (1) Which regimen will provide the client with the lowest tax rate? (2) Which will provide the client with the greatest flexibility in deploying and redeploying business assets?; and

• Social Security Tax Considerations. The third is choice of federal income tax regimen for Social Security Tax purposes. The relevant regimens are those listed above, but the relevant issues are entirely different from federal income tax issues. In addition, you won’t find the key authority in this field in the Internal Revenue Code or even in a final regulation—it’s a little-known but remarkably powerful IRS proposed regulation designated Prop. Reg. § 1.1402(a)-2.

Devoting appropriate time and consideration to these three areas can ensure an appropriate choice of entity and reduce risk and future loss for new business owners.