Why You Should Set Up Your Small Business as a Separate Business Entity

Editor’s Note: Sulaiman Al Rajhi is known as a billionaire without wealth because he gave away 16 Billion to charity. No matter how small your business, your ultimate aim must be to leave a substantial amount of your wealth on Waqf (Endowment). So whatever you leave behind will act as a legacy that continues to benefit others and yourself even after you are long gone. Don’t forget to watch the video at the end of the article that captures the essence of what business should mean to a Muslim

A separate business entity provides a simpler way of doing business where the transactions are recorded separately from a business and its owners. Every year, millions of new businesses are formed and legally structured in different ways, but the most beneficial business structure is the separate form, for example, Limited Liability Company (LLC) or S corporation.

As a separate business entity, you can operate with flexibility, simplicity, and most importantly to protect your personal assets against business losses or business liabilities.

In this article, we will discuss the business entities that are available in the U.S. Each country has different requirements in forming and maintaining the structure of the business, so it is very important that you find out in detail about the legal regulations in your country of residence and business.

This article does not represent legal advice or taxation advice. You need to seek the relevant specialist advice in your country or state.

Why should a business be a separate entity?

The main benefits of setting up a business as a separate legal entity are due to:

• Liability protection – the business owner, or shareholder ‘s personal assets will be protected against claims from any potential business liabilities or debts.
• Transferability – in the future, if the business owner or shareholder, can sell of their business to another person or company, entirely or partially.
• Tax breaks – for corporations, tax breaks means that the company can claim their business expenses in their calculation of taxes. However, this differs from state to state, and

4 Types of Business Entities

The business entity is essential for you to start, manage, and grow your business using a business structure that most fits your business needs. Business entity definition is simply referring to the form of incorporation for a business.

The structure that has been chosen for the business is determining who owns the business, the way how taxes are paid, and who is liable if a lawsuit or debt arises.

There are four groups of different entities in business, two of which have the benefits of a separate business entity:

• Limited liability company,
• Corporation,

For these two types of business entities, they have the drawback of not having a separate liability from the business owners

• Partnership,
• Sole proprietorship.

1 – Limited Liability Company (LLC)

LLC as a separate business entity is representing a unique form of business entity where business owners are called members. This is the best way to establish credibility and protect your personal assets. This method allows business owners to create a “corporate veil”, where the business owner’s personal assets have full protection in the event of lawsuits and unpaid business debts.

Let’s list the benefits of the LLC as a separate business entity:

1. LLC gives your business privacy
2. LLC owners are not limited to be US citizens or permanent residents
3. LLC gives the owners liability protection of business debts
4. Protecting your personal assets

If you want your small business to be and stay successful as a limited liability business entity, you should preserve your corporate veil by signing documents as the representative of the company and not as the individual. Also, you should keep your personal and business finances separate and follow an operating agreement in detail to avoid further problems.

To benefit your business, you should stay with a halal point of view and avoid any fraudulent activities. Not only that this is haram to do, by doing it you also guarantee yourself from failure.

2 – What is Corporation Entity?

The business structure of a corporation is the oldest form of business entity. Corporations are known as the preferred legal entity for businesses that are often publicly traded or are planning to be. One of the reasons to choose a corporate business structure as a separate entity lies in the plan to access public markets for investment capital.

When it comes to this business structure, there are different types of corporations:

• C Corporation (C Corp),
• S Corporation (S Corp), and
• Non-Profit or Not-for-Profit Corporation.

C Corp

Large companies are often formed as C Corporation because that is the most common business entity. The primary driver of this type of corporation form of legal entity is corporate finance law. C Corp enables the business entity to access capital markets and be listed on the stock exchange.

S Corp

It can be said that S Corporations are an earlier form of a limited liability company because they operate by combining the tax benefits of a partnership with the liability protection of a corporation. This entity can be used as a separate business entity.

Non-Profit Corp

There are multiple types of charitable corporations or non-profit organizations where one organization is having a different business structure from the example above and being based on the Internal Revenue Code.

3 – Partnership Entity

4 Types of Partnerships

There are few different types of partnerships that have different business structures, and these are:

• general partnership,
• limited liability partnership (LLP),
• limited partnership (LP), and
• limited liability limited partnership (LLLP).

General partnerships must have at least two general partners and every partner is personally liable for the debts and lawsuits against the partnership.

However, Limited Liability Partnership (LLP) and Limited Partnership (LP) act as separate business entities, where the limited partners have limited liabilities.

However, the general partner of an LP has unlimited liability, although he has the benefit of running the business, whereas the other partners are limited partners where they do not run the business but have limited liabilities.

In the case of a Limited Liability Limited Partnership (LLLP), it is similar to an LP, except that the general partner also has limited liability.

What’s important to mention is that the scope of limited liability varies widely from state to state and you should research for regulations in your state because these are mostly regulations that apply to the US.

4 – Sole Proprietorship

In this structure, a sole proprietor is a business owner, where it is also known as a one person business entity. A sole proprietorship can not be taken as a separate entity, and thus does not have the limited liability protection. This means that the sole proprietor is the business owner, and his or her personal assets are subjected to the liabilities and debts of the business.

If you operate your business as a sole proprietor and someone gets hurt on your premises, your personal assets may be compromised. For example, if you own a restaurant, and someone is injured or poisoned, your house, car, and bank accounts are available for the successful plaintiff.

How to set up a business as a separate entity?

The main goal to achieve is to separate the liability of the business from the liability of the individual owner, and the way to do that is to keep business accounting separate. To do this, best to choose an LLC or a corporation as a business entity, as generally, sole proprietorship and general partnership do not offer the protection of a limited liability.

So, for example, if you decide to invest or loan money to the business, it should be recorded as a loan or equity from an outside source.

Steps to set up the separate entity

The beginning of keeping your business as a separate entity is to register it with your state, and the next steps are:

1. Create a separate business checking account,
2. Use the tax identification number specified for business. This number is acting as a Social Security number but in this case, it’s for your business,
3. Have separate private and business transactions,
4. Keep written documentation of any money you withdraw from or put into the business,
5. Use the same payment method when you want to pay yourself as an employee that you use when you are paying to your other employees,
6. Pay tax personally,
7. Use loan documents if you want to put money into a business, it’s’ acting like a loan,
8. if you are using your assets for business purposes, make sure to record payments in the same way as any other separate entity (If you have a space in a building you own that is rented by the business, you need to record monthly lease payments to show the expense to the business and the income to your personal bank account)

(sources: the balance smb, berkman solutions)

In summary, it is best to choose a business entity that separates your personal assets from the business liabilities or business debts, and the best options for these are the LLC and the corporation business entity.

Editors Note: After you accumulated a significant amount of wealth, you should think about transferring everything or a significant part of your wealth to a foundation or corporate Waqf. This type of entity ensures that your wealth is managed in such a way that the proceeds from the business continue to benefit causes that you care about.

This video will explain what is the ultimate goal of any business entity should mean to a Muslim.