Choice of entity refers to choosing the legal form for operating your business. A business may be operated as (1) a corporation; (2) a general partnership or limited partnership; (3) a limited liability company (LLC); or (4) a sole proprietorship. Each state has its own laws for the formation, operation, and maintenance of these business entities.

The primary considerations in choosing the best form for operating your business are (1) protecting your personal assets from the liabilities of the company; (2) tax strategies designed to deduct early losses, avoid double taxation, and convert ordinary income into long term capital gain at a lower tax rate; (3) an entity that will be attractive to potential investors and lenders; (4) an entity that allows you to offer equity incentives to employees (stock options); and (5) the cost of forming the entity and properly maintaining it—including filing the required documents with state agencies.

In California, the choice of entity for operating a business is an important decision that affects liability, taxation, investment attractiveness, employee incentives, and administrative requirements. A corporation provides limited liability protection to its shareholders, but it may be subject to double taxation unless it elects S corporation status. General partnerships offer no liability protection to partners, while limited partnerships protect limited partners but not general partners. A Limited Liability Company (LLC) combines liability protection with pass-through taxation, making it a popular choice for many businesses. Sole proprietorships are the simplest form, with no separation between the business and the owner, meaning personal assets are not protected from business liabilities. Tax considerations vary by entity type, with corporations facing potential double taxation, while LLCs, partnerships, and sole proprietorships generally have pass-through taxation. Attractiveness to investors and the ability to offer stock options are typically greater in corporations. The cost of formation and maintenance, including state filings, varies by entity type, with corporations and LLCs typically requiring more formalities and higher fees than sole proprietorships or partnerships. An attorney can provide guidance on the best entity choice based on the specific goals and needs of the business.