Entity Structures: Overlooked, Underappreciated, and Underutilized

Posted on September 28, 2011 by Bill Faiferlick

Entity structures are perhaps the most overlooked and under-appreciated tool there is to help address many issues to  protect individual assets, reduce professional liability, manage risk, diversify income, reduce tax obligations, and provide certain options that may be otherwise unavailable.

Multiple entity structure usage along with their associated attributes and opportunities require careful consideration when conducting business and investment activities.

The importance of which entity structure you chose to conduct your business and investment activities through is critical and requires careful examination. Since each entity has unique characteristics and has both personal and business tax aspects, this requires more consideration than it is generally given. The selection directly relates to the type of opportunities you may or may not be able to utilize.  This seemingly routine decision will further reverberate to concerns not limited to your business activities, but how those activities and associated liabilities will directly flow to you as an individual or your partners.

Allowable benefits and deductions vary with different entities. Laws and corresponding opportunities in this area are changing and evolving. It is beneficial from a tax and liability perspective to understand which benefits are permissible under different scenarios to provide the most adaptable and flexible structures especially as situations change and as your business achieves greater success.

We all are working hard and striving to eek out the greatest financial rewards we are legally entitled to.You can choose to make it harder to succeed financially, or you can make it enormously easier to attain the monetary rewards you’re entitled to by having a business structure that can accommodate to demands as you grow. First appreciate the limitations and what they consist of because this decision could intentionally or not result in locking in or out some opportunities.

In my experience, CPAs often fail to anticipate the future needs of the business because they tend to concentrate on the past or present and immediate needs. This perspective or inability to see things from the owner’s viewpoint will result in you missing valuable financial opportunities. I encourage you to inquire of your CPA to confirm which benefits are deductible within your entity. Changing entity structures to take advantage of allowable benefits and retain greater control of the wealth being created typically needs to occur at least a year, in some instances two to three years, before the organization experiences increases in revenue or liabilities, not during or immediate following the increase.

Entity Structures Considerations

 

  • Multiple entity structures – Don’t put all your eggs in one basket – seriously consider using multiple entities because if a genuine business purpose can be determined, this may limit liability exposure.
  • Selection of entity structures provide different benefits, protection and opportunities.
  • Incorporating doesn’t eliminate lawsuits, but it really reduces the depth of a person’s pocket. Determining which entity will hold hard assets helps to reduce risk in a higher risk enterprise. “A rarity just a decade ago, the million dollar plus award is now merely average in San Francisco and Cook County.” (Forbes, October, 1989)
  • Enhance privacy and provide increased levels of liability protection without buying increased coverage.
  • Why should a business owner, professional or affluent individual risk all of his own assets that they have spent a lifetime accumulating? The short answer is, they shouldn’t!

Using multiple entity structuring of businesses and assets is frequently underutilized in large part due to the advice from advisors who generally fail to fully comprehend the risk associated with specific careers or professions.

In fact, many accounting firms may disagree in principal because they fail to understand how entity selection, or the application of multiple entity diversification affects benefits and liability exposure.

This type of diversification is necessary for many from a risk management perspective. A lawsuit is filed every 30 seconds in the US. With many professionals, one of the single largest concerns is asset protection especially when there is expensive equipment, real estate or other hard assets within the business or enterprise. Professionals generally tend to find themselves more at risk due to the perception that they have assets, increased net worth, and almost always carry higher liability coverages.  As a result, they are more easily targets of litigation as any litigation attorney will tell you.

Expensive liability insurance can be an attractant and comes with its own complications. Liability for many professionals, for example, is not solely limited to their practice. If a professional is sued and fears losing, they settle. Without multiple entity structuring, the opposing counsel would be able to ascertain the value of your practice including the debt free assets at the click of a mouse. As a result, attorneys will ask for and receive large awards. Had the assets been owned in a separate entity, the value of the practice may be limited to the value of assets in that entity and the income generated from that entity. You must clearly and objectively evaluate  your propensity to risk since it can go well beyond your business assets; to the income from the business, investments, homes, cars, real estate etc. How well do you want to sleep at night is largely determined by the amount of risk your willing to personally assume.

Anyone who has assets needs to assume that there is someone who is willing to take what is yours if they’re given the opportunity. Unless prudent action is taken after examining multiple scenarios you might best view yourself as are merely a temporary custodian of that which you’ve acquired over your lifetime. An accountant might charge that these are isolated incidences and they are, until they happen to you. There are thousands of such cases published in legal publications each year.

Question: do you carry fire insurance on your home? Why?

Because for most people if their home were to burn down, you would still owe the mortgage debt without a home on the property.

It’s cost effective to anticipate a disaster that statically will never occur to you until it does. Yet we are willing to go out into this world having young children driving cars, we as adults, are ultimately responsible for. You cannot buy enough coverage if your child were to somehow really hurt another person while driving. We, as parents, will be found financially responsible. Can you afford to pay a $10 million dollar award? We live in a global society where things can and do happen all the time. Why would you choose to leave yourself financially exposed?

Consider just a few of the monetary rewards that lie within entity diversification: tax savings, flexibility, succession planning, and risk management. There are many more I have not even touched on but I trust you are beginning to get the idea. The decision is yours about the value you place on what you may have worked a life time to acquire or hope to attain.