What Is a Legal Entity? Definition & Examples

The business world is made up of thousands of legal entities. In simple terms, a legal entity is an individual, business, or organization that has specific legal responsibilities. These duties are set by various governing bodies, ranging from your local city council to the federal government

This term has evolved over time but remains rooted in the need for a regulated business landscape. Legal entities ensure there’s a structure that’s accountable for its actions within the jurisdictions of federal, state, and local laws.

What Are Some Examples of Legal Entities?

You might recognize the different types of legal entities from previous ventures or your own research — limited liability companies, general partnerships, and nonprofit organizations.

Corporation

When you think of business entities with a solid structure, corporations usually top the list. Often governed by a board of directors, corporations are separate legal entities that provide a strong shield against personal liability.

Corporations pay a corporate tax to the IRA and often deal with double taxation if they are C corporations. On the global front, corporations may require a legal entity identifier (LEI), especially if they’re participating in the global LEI system.

Partnership

Partnerships are business organizations where two or more individuals manage and operate a business in accordance with a partnership agreement. They’re often subject to income tax and are generally easier to set up than corporations.

General partnerships, and sometimes limited liability partnerships, are common types of partnerships, each with its nuances when it comes to personal liability and legal rights.

Sole Proprietorship

A sole proprietorship is often the first stop for budding entrepreneurs. It’s a business structure where a single individual runs the show. While this type offers fewer hoops to jump through in terms of setup and compliance, it leaves the owner open to personal liability.

In essence, a sole proprietor’s personal assets could be at risk if the business incurs debt or legal issues. If a person is running a small business by themselves, they may choose to legally become a sole proprietor.

LLC

The limited liability company (LLC) is a versatile legal entity, borrowing beneficial features from both corporations and partnerships. True to its name, an LLC offers the perk of limited liability protections, making it a reliable choice for businesses keen on avoiding the pitfalls of double taxation.

Rules and regulations for LLCs can differ depending on the jurisdiction as well as specific state laws.

Joint Ventures

A joint venture is a business entity formed between two or more parties for a specific project or business activity. Much like a regular partnership, each party in a joint venture retains its separate legal entity status but agrees to work together for a mutual benefit.

These entities often have specific legal rights and obligations outlined in a partnership agreement, adding a layer of accountability.

What Are the Tax Differences Between Legal Entities?

In the world of business structures, the sole proprietorship is often hailed for its simplicity. If you’re the sole owner, you’ll claim all the business’s income, and usually, there’s little to worry about complex federal laws.

In a sole proprietorship, all business income gets reported through personal income tax returns. While this might seem convenient, it has a downside: The owner is personally liable for all business debts and any legal complaints that might be filed against the company. So, if the business faces financial setbacks, personal assets — like a home or car — could be at risk.

Sole proprietorships could result in higher tax obligations compared to other business structures like LLCs. Even if there aren’t as many regulatory hurdles, you’ll want to meet with a tax professional to ensure you’re making the right business structure decision for you and your business partners.

How Do You Form a Legal Entity?

Forming a legal entity takes some basic steps, no matter which state you live in.

1. Check State Laws

Each state in the U.S. has its own regulations for forming business entities. Make sure to consult your state government website to understand the specific laws that will apply to your business.

2. Pick the Best Legal Structure for Your Business

The structure you choose for your business, whether it’s a sole proprietorship or an LLC, will affect how you report income, your level of personal liability, and how you can raise capital. Do some research and consult with your business partners to ensure you’re making the right choice.

3. Write Contracts for Shareholders, Owners, or Directors

If your business structure involves shareholders, owners, or a board of directors, create contracts that specify each party’s role, responsibilities, and profit-sharing ratios. This documentation is often a legal requirement as well.

4. Register Your Business

To formalize your business entity, you will need to register it and file articles of incorporation or similar documentation with your Secretary of State office, depending on your chosen structure. This registration gives your business its legal rights and responsibilities.

5. Ensure You Have the Right Permits and Licenses

Different types of businesses require various permits and licenses to operate. You’ll need to check both federal and state requirements to ensure you’re in full compliance.

6. Obtain an Employer Identification Number (EIN)

An EIN is basically a Social Security number for businesses that you file with the IRS. You’ll need to pay taxes and potentially open a business bank account.

What Is a Legal Entity Identifier (LEI)?

The legal entity identifier serves as a universal, unique identifier for participants in global financial transactions. With a 20-character, alpha-numeric structure, the LEI is designed according to the ISO 17442 standard set by the International Organization for Standardization (ISO).

The LEI is like your business’s ID card on a global stage. It tells everyone important details about who owns your business and how it’s structured. This makes financial transactions more transparent, especially because this LEI data is publicly available.

The Financial Stability Board (FSB), which monitors the global finance system, emphasizes the importance of the worldwide adoption of LEIs as they’re a framework that aids in better risk management and enhances the stability of the financial sector. The LEI also contributes to improving both micro and macro-prudential risk assessments.

Another plus for LEI is that its use supports higher data quality and accuracy to maintain the integrity of financial data.

Can You Switch Legal Entities?

A common myth is that your choice of a business entity is permanent. Businesses evolve, and so do their needs, whether it’s a change for tax optimization, acquisition, or a merger.

Business owners might contemplate a change in their business structure for various reasons. Here are some common catalysts:

Tax optimization: One of the most compelling reasons for a change could be potential tax benefits. For example, moving from a sole proprietorship to an LLC or a corporation could offer more favorable tax conditions.
Business growth: If a business is expanding, it might need a more complex structure to support that growth, like moving from a sole proprietorship to a corporation.
Mergers and acquisitions: Joining forces with another company? A change in business entity might be part of the negotiation.

Changing your business entity requires careful planning and execution. You’ll need to consult tax and legal professionals to ensure the change aligns with your business objectives and complies with state and federal laws. Also, you’ll need to update your business registration and perhaps even draft new articles of incorporation.

Set Up Your Legal Entity for Success With Mosey

No matter the legal entity type, business owners must always comply with local and state laws. Mosey specializes in helping businesses nail the compliance game. Whether you’re just starting out as a new startup founder or looking to get your multi-state corporation up to snuff, Mosey can guide you through the necessary steps to ensure you’re operating in full compliance with state and local laws.

The road to business success is smoother when you don’t have to worry about stumbling over legal hurdles. Take the first step toward hassle-free compliance. Trust Mosey to set your legal entity on the path to success.