Business Set Up and Choice of Entity

Work with an Experienced Michigan Business Lawyer

The way you structure your business, legally and for tax purposes, has a direct impact on your income taxes, personal liability, succession planning, probate avoidance, and long-term wealth preservation.

Anyone can log into the State of Michigan Corporations Division website and create a Michigan LLC or corporation. You just follow the prompts, pay a $50 filing fee, and the State registers your new legal entity. Then you can file online for a tax identification number (an EIN) with the Internal Revenue Service. Take the State of Michigan paperwork and your EIN to your local bank, and you can start doing business. Or maybe not.

There is more to establishing and maintaining a legal entity than filing a couple forms with the state and federal government. Too often, Michigan entrepreneurs set up an entity without considering how that decision affects income taxes, retirement, asset protection, estate planning, prospects for an eventual sale, and future generations. A well-chosen entity structure is one of the most practical and cost-effective tools available to protect what you’ve built and working with an experienced business lawyer is the best way to ensure you make the correct choice.

Why Business Structure Matters

In Michigan, businesses are formed primarily under:

• The Michigan Limited Liability Company Act (MCL 450.4101 et seq.)
• The Michigan Business Corporation Act (MCL 450.1101 et seq.)

Both statutes offer liability protection and organizational flexibility. But how you elect to be taxed, the options including as a disregarded entity, partnership, S-Corp, or C-Corp, create dramatically different outcomes.

Tax Elections: The Most Important and Most Misunderstood Step

Many Michigan entrepreneurs form an LLC and assume they’re done. But the tax classification is often more important than the legal structure itself. A knowledgeable business lawyer will stress that optimizing your tax classification is the most critical component of your entity setup.

Disregarded Entity a/k/a Single-Member LLC

Perhaps the most common choice of entity for single owner operations. This structure is best for rental properties for single or married couples, and professional service providers especially those that have few employees, if any. The IRS treats the business the same as a sole proprietorship.

Pros:

• Simple tax reporting
• Full deduction of legitimate business expenses

Cons:

• Entire net profit subject to self-employment tax (15.3%)
• Zero ability to reduce payroll tax through a reasonable-compensation structure
• No co-owner flexibility
• Creates probate issues unless ownership is coordinated with your trust

Partnership (Multi-Member LLC)

When two or more people conduct business as an LLC it is considered a partnership by default. These entities are best for multi-owner rental real estate operations, or for family businesses that are being passed down to the next generation.

Pros:

• Flexible profit allocation (IRC §704)
• Ability to shift deductions and losses
• Allows for inside/outside tax basis optimization

Cons:

• All “earned income” components subject to self-employment tax
• More complex tax preparation (Form 1065 + K-1s)

S-Corporation Election (LLC taxed as S-Corp)

Often the best choice for Michigan service businesses, professional practices, retail or manufacturing businesses, and for owners who earn significant income (over $200,000/year).

Within reason you can allocate your profits between a reasonable salary which is subject to payroll tax and the remaining profit which may be distributed payroll tax free. Savings often exceed $10,000–$30,000/year for high earners.

S-Corps are powerful but must be coordinated with your estate plan so that ownership passes into the correct trust without terminating S-Corp status. And maybe more importantly, you must consider your age and time horizon for retirement, and if the business operation will be sold or if a family will take over. If you S-Corp is likely to be passed onto the next generation, there are basis income tax adjustments that are disadvantageous. Consulting with a business lawyer is essential to ensure you meet all Michigan requirements for S-Corporation status, including:

• File IRS Form 2553 on time
• All shareholders must be individuals or certain trusts
• Michigan treats S-Corp income as “flow-through” for state tax purposes

C-Corporation

C-Corps create “double taxation,” but strategic planning (reasonable compensation, rent, dividends timing, equipment intensive operations) can neutralize that impact. And when it no longer makes sense to operate as a C-Corp, you may elect S status. Usually not the best choice for small Michigan businesses, but sometimes appropriate for:

• Startups expecting outside investment
• Businesses building retained earnings for large capital purchases
• Operations that require extensive start up financing
• Owners seeking fringe benefits not available in S-Corps
• Certain advanced tax planning scenarios

How a Business Lawyer Can Help Keep Risk Out of Your Personal Life

Michigan’s LLC statute (MCL 450.4501) provides strong “charging order” protection, particularly for multi-member LLCs. This can prevent a creditor from forcing a sale of business assets or obtaining control of your company.

Key protections available in Michigan:

• Shielding your personal assets from business liabilities
• Preventing your business partner’s creditors from stepping into ownership
• Protecting rental properties from tenant lawsuits
• Isolating each business line or real estate parcel in separate LLCs

Business owners often overlook that operations and assets should not be held inside the same entity. A common structure:

• Operating LLC (conducts business, employs staff)
• Holding LLC (owns real estate, equipment, Intellectual Property; leases to Operating LLC)

This separation is one of the most powerful forms of risk management.

Probate Avoidance: Your Entity Must Tie Into Your Estate Plan

It’s not surprising that most Michigan LLCs and corporations are legally owned by individuals and not directed to the owner’s trusts to avoid probate. When that owner dies:

• The membership interest goes through probate,
• Voting rights freeze,
• Banks lock accounts,
• Tenants may stop paying rent,
• And business operations stall.

The fix is simple: Assign your membership interest or shares to your Revocable Living Trust.

This avoids probate and ensures your successor trustee can continue operating the business immediately upon your incapacity or death. Alternatively, you may establish a Transfer on Death designation (or “TOD”) and direct that the ownership of your entity be transferred directly to a specified person after you die.

Do I Need Michigan Business Lawyer?

The single biggest mistake Michigan business owners make is assuming the “default structure” is good enough. It isn’t. A carefully selected and properly coordinated entity structure:

• Minimizes taxes every single year
• Protects your personal assets from business risk
• Avoids probate court involvement
• Ensures your company survives incapacity and death
• Preserves wealth for your children and grandchildren