When Selecting a Business Entity – Which Business Entity Is Best For Your Business?
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Note: This is merely an overview and should not be considered as legal or tax advice. Please consult an attorney and/or accountant.
Our Thanks to our sister company, Diversified Business Online for use of the following:
Make In-Depth Review of Long-Term Business Goals
Before deciding on which business entity to use, it would be useful to make an in-depth review of your long-term business goals. This decision will have lasting implications, and a bad initial decision can have long-term, sometimes irreversible repercussions.
Some things to consider are:
- Your plan regarding size and nature of the business
- Expected profit (or loss), short-term and long-term
- Nature of business and vulnerability to lawsuits
- Number of partners
- Does your business have employees?
- Plans for a future sale of business
- Initial business capitalization
- Future plans for going public
- Tax implications of different business entities
- Future ability and ease of obtaining financing
BASIC BUSINESS STRUCTURES
Advantages and Disadvantages of each
Sole Proprietorship
The Sole Proprietorship is the simplest means of holding ownership of a small business. The owner is the operator/manager of the business, can easily transfer ownership, and reports profit and loss on a personal 1040 Individual Income Tax Return on attached Schedule C.
While the majority of small businesses in the USA are held as Sole Proprietorships, this may not be the best method from a tax and legal liability standpoint.
The owner is personally liable for all business debts and is personally liable in the event of lawsuits.
See Sole Proprietorship (SBA.gov)
Partnership
If you have a business with a partner(s), you will be deemed a Partnership unless you form a corporation or some other business structure. The partnership does not pay taxes but must file an informational return, and the individual partners report their share of profits and losses on their personal 1040 tax returns. The operation is the same as the Sole Proprietorship with one additional caveat. If your partner(s) incur liability (even if against your wishes and without your knowledge), you may also be exposed to this liability. For this reason alone, you should investigate another form of ownership.
Limited Liability Company (LLC)
A limited liability company is similar to a partnership but has the liability protection of a corporation. Limited liability companies are easier to administer than corporations, and the paperwork is less cumbersome. From a tax standpoint, the LLC provides the advantages of a partnership and sole proprietorship. Profits and losses can be passed through the company to its members, or the LLC can file for an election to be taxed as a corporation.
See Limited Liability Co. (LLC) (SBA.gov)
C-Corporation (INC. OR LTD.)
This business structure provides personal liability protection to the owners (stockholders); however, it is more complex than other forms. A “C” Corporation is a separate legal and taxable entity; taxable under Subchapter C of the IRS Code. A C-Corporation files a Form 1120 and pays taxes as a separate legal entity, separate from the shareholders. This is often referred to as “double taxation” since the corporation pays taxes as do the individual stockholders on their personal 1040 tax returns.
S-Corporation (Sometimes called a Sub S Corp)
From a tax standpoint, an option is available to avoid the double taxation encountered with the C-corporation. By filing Form 2553 with the IRS (if approved), the corporation is treated as a Subchapter S-Corporation for tax purposes. The S-corporation is treated as a “pass-through” tax entity, where the profits are not taxed to the corporation. Instead, the profits pass through to the shareholders, who pay personal income tax on their individual 1040. In order to gain approval by the IRS to obtain Subchapter S status, you must meet certain IRS requirements.
See S-Corporation IRS (SBA.gov)
Care must be taken that the corporate formalities are observed (annual filing, corp. minutes, resolutions etc.).
Should your corporation be sued, this becomes extremely important in maintaining the corporate veil of protection from personal liability.
We can not overemphasize the importance of doing proper research and planning when setting up your company. This can save a lot of headaches later on when in operation.
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