Which Business Entity Should You Choose When Starting a Business & How Will It Affect Your Estate Plan?

Which Business Entity Should You Choose When Starting a Business, and Why Does Your Estate Plan Matter?

When you take the leap from idea to enterprise, the excitement of launching a new venture often overshadows one of the most critical decisions you will make: which business entity should you choose when starting a business? The structure you select — sole proprietorship, partnership, limited liability company (LLC), S corporation or C corporation — affects everything from taxes and personal liability to how you raise capital and manage the company day to day. Less obvious, but equally important, is how your choice influences your estate plan. Business ownership is a significant asset. If you fail to integrate entity selection with your estate planning goals, you could saddle your heirs with unexpected taxes, disputes and administrative hurdles. This article explores how to align these two decisions so your business thrives now and your legacy endures.

The Interplay Between Business Formation and Estate Planning

Most entrepreneurs focus on operational and tax implications when choosing an entity. They ask: How much paperwork will this require? Will my personal assets be protected? How will this affect my annual tax bill? These are crucial questions, but they only tell part of the story. Your business may outlive you, or you may decide to sell or transfer it during your lifetime. The way your business is structured determines how ownership interests can be gifted or inherited, whether a trust can hold those interests, and what happens if you become incapacitated. Your estate plan, in turn, should reflect the entity’s rules and your succession goals.

For example, a sole proprietorship ends when you do. Its assets become part of your probate estate, potentially delaying access for your heirs. In contrast, shares of a corporation or membership interests in an LLC can be held in a revocable trust, allowing for smooth transition without court involvement. Partnerships and LLCs often require buy-sell or operating agreements specifying what happens upon an owner’s death. Failing to coordinate these agreements with your will or trust can lead to conflicting instructions and litigation. Choosing the right entity when starting a business should therefore be a joint conversation between your business advisor and your estate planning attorney.

Sole Proprietorship: Simplicity Now, Complexity Later

A sole proprietorship is the simplest and most common form of business ownership. You are the business, and the business is you. There is no legal distinction between your personal assets and the company’s liabilities or profits. This simplicity makes it attractive for freelancers and small, low-risk ventures. It also means there are no formalities for formation or ongoing compliance.

From an estate planning perspective, however, a sole proprietorship can be problematic. Because the business is not a separate legal entity, it cannot own property or be transferred as a distinct asset. When the owner dies, the business ceases to exist. Any assets used in the business — such as equipment, inventory or client lists — must be distributed through probate or according to the terms of your will. This process can delay operations, frustrate customers and reduce the business’s value. If you want your business to continue beyond your lifetime, consider forming an entity that can hold assets and survive you. Even if you remain a sole proprietor, you should have a clear plan in your will for who will take possession of the business assets and whether they have the skills and desire to carry on.

Partnerships: Shared Ownership and the Need for Agreements

Partnerships allow two or more people to share ownership and responsibility. General partnerships are easy to form but provide no liability protection: each partner can be held personally liable for the debts and actions of the business. Limited partnerships (LPs) and limited liability partnerships (LLPs) offer more protection by distinguishing between general partners, who manage the business and carry liability, and limited partners, who are passive investors. Regardless of the type, a written partnership agreement is essential.

Estate planning becomes particularly important in partnerships because ownership interests may not automatically transfer to your heirs. Partnership agreements often include buy-sell provisions or rights of first refusal, giving remaining partners the option to purchase a deceased partner’s share. These provisions prevent unwanted outsiders from entering the business but also mean your heirs may not inherit what you expect. You can work with your partners to ensure that life insurance or other funding is available to buy out your interest so your family receives fair compensation. Your will or trust should coordinate with the partnership agreement, specifying how your partnership interest will be valued and whether it will be sold or placed in trust. In some states, a partnership interest must pass through probate, but if your interest is held by a trust, the transition can be quicker and more private.

Limited Liability Companies: Flexibility and Protection

The limited liability company has become a favorite for startups and family businesses. An LLC offers liability protection similar to a corporation but with greater flexibility in management and taxation. Members can choose to be taxed as a partnership (pass-through taxation) or as a corporation. The company’s operating agreement governs capital contributions, voting rights, profit distributions and what happens if a member dies or wishes to withdraw.

An LLC’s flexibility extends to estate planning. You can place your membership interest into a revocable trust, allowing the trustee to manage it if you become incapacitated and enabling a smooth transfer to beneficiaries without probate. You can also gift noncontrolling membership interests during your lifetime to take advantage of annual exclusion gifts and potentially reduce estate taxes. If the LLC elects to be taxed as an S corporation, you must ensure that any trust receiving your interest qualifies as a permitted shareholder (either a Qualified Subchapter S Trust or an Electing Small Business Trust) to avoid terminating S corporation status. In high-value LLCs, consider using family limited liability companies or family limited partnerships to leverage valuation discounts and retain control while transferring wealth to the next generation.

Corporations: Continuity and Formality

Corporations are separate legal entities that offer robust liability protection and perpetual existence. Shares can be freely transferred unless restricted by shareholder agreements. This continuity is attractive for larger businesses or those seeking outside investment. There are two main types: C corporations and S corporations. A C corporation is subject to corporate income tax, and dividends distributed to shareholders are taxed again at the individual level, resulting in double taxation. An S corporation avoids this by passing income and losses through to shareholders’ personal tax returns, but only certain types of shareholders — generally U.S. individuals and specific trusts — can hold stock.

For estate planning, corporate shares are relatively straightforward assets. They can be held in trust, gifted or bequeathed in a will. A shareholders’ agreement or buy-sell agreement can govern how shares are transferred upon death. Such agreements can require that remaining shareholders or the corporation buy back the shares, ensuring that ownership stays within a specified group and providing liquidity to the estate. S corporations introduce additional complexity: if your estate or trust holds S corporation stock, you must ensure that the trust qualifies to own it. Otherwise, the corporation could lose its S election, resulting in unexpected tax consequences. When forming a corporation, think ahead about who might inherit shares and what structures will preserve the tax status and control you want.

Factors to Consider When Choosing Your Entity

Selecting the right entity is not merely about your initial business vision. It involves a holistic assessment of your personal financial and family situation. Choosing the right entity when starting a business requires you to consider liability exposure, taxation, management preferences, growth plans and estate planning goals. Entrepreneurs with significant personal assets may prioritize liability protection and choose an LLC or corporation. Those planning to bring in investors might lean toward a corporation for easier share transfer. If your goal is to build a family business that lasts generations, an LLC or closely held corporation with a well‑drafted operating or shareholder agreement and integration with trusts might provide the right balance of control, flexibility and longevity. Alternatively, if you view your business as a stepping stone or side venture, a simpler structure like a sole proprietorship or partnership might suffice, provided you understand the estate implications and plan accordingly.

Integrating Your Business and Estate Plan

Once you choose your entity, the next step is to integrate it with your overall estate plan. This integration ensures that your personal and business objectives support each other rather than clash. Key strategies include:

• Creating or updating your will and trusts to address your business interests explicitly. Outline who should inherit your ownership interest, how it should be managed and whether it should be sold, continued or dissolved.

• Funding trusts with business interests when appropriate. A trust can provide continuity, management oversight, and protection from creditors or divorcing spouses, while distributing income to beneficiaries according to your terms.

• Reviewing beneficiary designations for retirement accounts or life insurance to ensure they align with your business succession plan. Your ex‑spouse or former business partner may still be a beneficiary on some accounts; update them promptly when circumstances change.

• Executing buy-sell agreements or operating agreements that specify what happens to your share upon death, incapacity or divorce. Coordinate these documents with your estate plan so they do not conflict or create unintended tax consequences.

• Evaluating tax implications of transfers. Work with tax professionals to understand estate and gift tax exemptions, valuation discounts, and potential income tax consequences of different entity structures and transfer strategies.

Conclusion: Asking the Right Questions Today for Peace of Mind Tomorrow

Starting a business is a leap into the unknown, but the choice of legal entity should be anything but guesswork. Asking Which business entity should you choose when starting a business — and how will it affect your estate plan? forces you to think beyond short-term convenience to long-term security. The decision you make at formation shapes not only your liability and taxes but also the future ownership, control and value of your business for your loved ones. By considering how different entities intersect with estate planning, you can build a company that supports your goals, protects your family and preserves your legacy. Work with experienced legal and financial advisors to evaluate your options, draft the necessary agreements and ensure that your business formation and estate plan work together seamlessly. That careful planning today will allow you to focus on growth and innovation, confident that your hard work will benefit generations to come.