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An "Entity Identity" Update (Part One of a Two-Part Article)

By understanding the distinctions between different Pennsylvania business entites, people will be better able to determine which entity is best designed for their respective businesses. In Part One of this Two-Part article, I answer some oft-asked general questions about selecting a business entity.

[Portions of this article are based upon an article I wrote for and which was published by both the December, 2018 Pennsylvania Bar Association's Solo & Small Firm Newsletter and the January, 2019 Pennsylvania Bar News. --KPM]

What types of business entities are recognized in Pennsylvania? Thirty years ago, there were only a handful of recognized business entities in Pennsylvania: Sole proprietorships, general partnerships, limited partnerships, S corporations and C corporations. In the 1990s, Pennsylvania enacted legislation which provided for limited liability companies and limited liability partnerships. In addition, Pennsylvania now allows for the formation of "Benefit" entities, i.e., entities which allow decision-makers to take into consideration one or more social issues (such as environmental or educational concerns), instead of making decisions based solely on the effect upon the monetary value of an equity holder's ownership stake.

Will the type of business I choose have an effect upon which entity works best for me? Sometimes. For example, Pennsylvania has special rules for entities whose owners are limited to to being attorneys, doctors, engineers, accountants and other "professionals." However, most decisions regarding entity selection are based more upon tax, liability and flexibility issues than upon the nature of the business. For example, if an accountant advises that the owners of a company are better off taking a "salary" as opposed to receiving periodic "distributions," an S corporation may be preferable to a limited liability company. On the other hand, a limited liability company will likely be the preferred entity if a company's success depends upon obtaining investments from other companies. That is because S corporations have restrictions upon who can be an investor in or equity holder of the company, while limited liability companies have no such restrictions.

What if I want to start a business with my spouse or other family member? This is a huge concern when selecting a business entity. Many people don't realize that, unless a specific entity is properly formed and maintained, any business owned by two or more people is going to be treated under Pennsylvania law as a general partnership. General partnerships are a liability nightmare: Each partner, and all of the partners together, can be held personally responsible for the entire amount of partnership debts and obligations. If spouses start a business and don't properly form and maintain the business entity, and if the business runs into financial difficulty, not only will the assets of the business be at risk, but the family home, cars, bank accounts and everything else owned by them, individually or jointly, will be at risk.

[In Part Two of this article, I will answer questions regarding the changes during the past five years which have transformed Pennsylvania into one of the most progressive states in the nation in terms of entity transformation and flexibility.]

---Ken Milner