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

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

For decades, business professionals shunned Pennsylvania because its entity laws were some of the oldest in the country. Pennsylvania was one of the last to modernize its regulations regarding the means by which entities could be modified or restructured. Over the past five years, however, Pennsylvania has passed a series of laws which have vaulted the Commonwealth into one of the most progressive states in the nation in terms of entity transformation and flexibility. In the following series of questions and answers, I will provide examples of how these changes in Pennsylvania entity law can be a benefit--and a possible trap for the unwary.

Can I change my entity form after I start my business? Until a few years ago, the answer would have been "no." For example, if you had formed a corporation and wanted to change it to a limited liability company, you would have had to dissolve the corporation and then form the limited liability company as a new entity. It was time-consuming and expensive. Now, Pennsylvania has adopted a streamlined procedure which allows you to "convert" your corporation into a limited liability company. The Pennsylvania Bureau of Corporations and Charitable Organizations ("the Corporation Bureau") has adopted and approved for use simple conversion forms. Using these forms takes away the necessity of having to formally dissolve the corporation. This translates into savings of many weeks of time and hundreds, if not thousands, of dollars in professional fees required for proper dissolution.

Is the conversion process the only change? No. Simplified entity conversion is only one example of Pennsylvania becoming a leader in terms of entity flexibility and innovation. Other examples are the relative ease of changing the domesticity of the entity (e.g., from an Arizona entity to a Pennsylvania entity), or merging one company with another company, even if the two companies are different types of entities, and even if the the merged company becomes a third type of entity.

What other professionals/ individuals should be involved in deciding the entity form? The recent developments in Pennsylvania entity law, and the relative ease of filing entity forms are as much a trap as they are a convenience. When there were limited options and relatively stable tax situations, it was fairly easy to select an entity just by marshalling some background information about the financial and general circumstances of the people forming the entity, and by briefly consulting with the accountants or financial advisors of the interested parties. Now, with so many entity options available, with the rapidly changing laws and regulations in virtually every field of business, and with equally rapid changes in overarching insurance, employment, tax and long-term planning disciplines, a person trying to form even the simplest entity without professional help can easily miss something important or make a mistake far more costly than the fees the person would have paid to the professional advisor(s).

Therefore, when a potential client asks me about forming or changing a business entity, I always take an holistic approach. I start with an initial client consultation. During the consultation, I obtain a comprehensive picture of the personal situation of the client, the purpose of the entity to be formed, and the history of the business (if already existing). I will want to understand the way the company will be financed, mangaged and operated, and I will want to know the short-term and long-term plans of both the client, including an exit strategy. Then I usually advise the client that, before finalizing anything, we will want to consult with the client's accountant and other professional advisors, as well as anyone else who can provide insight into the client's situation.

Won't this be expensive? Will I really want to go to all this trouble just to form a simple corporation or limited liability company? There is little doubt that following my suggested procedure will cost more than simply having your tax preparer or a service such as LegalZoom, fill in and file some forms. However, you must remember that the primary purpose of forming a business entity is to minimize the risk of your being held personally liable for claims and obligations arising from the ownership and operation of the business. If the entity you form is not properly formed and maintained, creditors and claimants could "pierce the entity veil," and your personal assets will be at risk, i.e., the one thing you were trying to prevent. Moreover, if you don't take into consideration everything else going on in your life, and if you don't make sure your lawyer's efforts dovetail with what your other advisors are having you do, you could find yourself with significant additional taxes or other costs. In most cases, it will make sense to spend a little more time and money up front, than to spend a lot of time and money dealing with a problem that could have been avoided.

----Ken Milner