The most important decision when starting a business is deciding what type of business entity best suits your needs. The business entity you choose can have serious consequences regarding liability and taxation. This article will help you better understand your options by comparing two of the most popular choices.
What is a business entity?
One or more natural persons create a business entity to carry on a trade or business. Business owners often favor corporations and LLCs because they offer several layers of protection for their owners.
The following are types of business entities:
- Limited liability company: A registered business with limited liability for all members
- Professional limited liability company: An LLC structure for professionals, such as doctors and accountants
- C-corporation: An incorporated business composed of shareholders, directors, and officers
- S-corporation: An incorporated business that is taxed as a pass-through entity
- Professional corporation: A corporate structure for professionals, such as doctors and accountants
- B-corporation: A for-profit corporation that is certified for meeting social and environmental standards
- Nonprofit: Corporations: A formed primarily to benefit the public interest rather than earn a profit.
What is personal liability?
Personal liability means that your personal assets will be exposed if one of your co-owners or employees commits an unlawful action that injures someone, such as writing a defamatory article or post. If there is a judgment against your company, it can be satisfied by reaching into your bank account, home, or automobile simply because of your status as an owner of the company.
You also need to be aware of different taxation among different business entities.
Business entities have a great effect on government taxation.
Before we get to corporations and limited liability companies, let’s talk about some other business entity options which include:
- Sole proprietorship: A business that is unincorporated with one owner or jointly owned by a married couple
- General partnership: A business that is unincorporated with two or more owners
- Limited partnership: A business that is registered and composed of active, general partners and passive, limited partners
Sole Proprietorship
If your company is going to be fairly small a sole proprietorship might be the right business entity for your needs. You, as the owner, will be in control of all day to day decisions and profits.
The greatest disadvantage of a sole proprietorship is that there is unlimited liability. The owner will be personally responsible for business debts and losses.
This is great for the type of person who truly enjoys independence and wants to make their own rules without answering to others. You are your company and are okay with there being no formal division.
The business and the owner are legally the same. From the IRS’s perspective, the business is not a taxable entity. The company assets and liabilities belong directly to the company owner.
Partnerships
A partnership is similar to a sole proprietorship except that there is more than one individual that owns the business. The liability of the partners for the debts of the company is unlimited and this means that each partner is ‘jointly and severally’ liable for the partnership’s debts; that is, each partner is liable for their share of the partnership debts as well as being liable for all the debts of the business.
If you are someone who enjoys working with a team and does not want to shoulder all the responsibility for the company yourself, a partnership might work for you. If you have the right blend of personalities you can complement each other quite well and be stronger than any of the partners could ever be on their own.
As with sole proprietorships, the business and the owners (two or more) are legally the same. A partnership is not a taxable entity under federal law.
Limited Partnership
A limited partnership contains two distinct types of partners:
- General Partners
- Limited Partners
The general partners run the day to day activities of the business. The general partners are also personally liable for a business’s debts and liabilities.
The limited partners do not have much to do with the way a company is run. They have limited liability concerning a business’s debts and they usually pay fewer taxes regarding the profit. These are silent investors who bring in money but do not run the business.
If you want to retain primary authority in your organization but definitely could use some other sources of cash than a limited partnership would be a great compromise.
C-Corporation
C-corporation (c-corp) are separate entities from their owners. A c-corp consists of shareholders (the owners), a board of directors, and officers who have control over the corporation. One person can fulfill all these functions.
The great advantage of a c-corp is that the owner/owners are not personally liable for the debts and liabilities of the company. The disadvantage is that there is double taxation on profits. The government will tax the corporation as a separate entity. You should think of the corporation as a fake person in the eyes of the Internal Revenue Service.
This is a great model for those who really want to start a company that is quite large in scope and size. However, you will be answerable to your shareholders for good and bad outcomes of your business decisions.
S-Corporation
If your corporation has fewer than 100 shareholders who are all individuals, not corporations; have only one class of stock, and be owned by U.S. citizens or resident aliens you could turn your business into an S-Corporation (s-corp).
An s corp is not subject to double taxation as a c corp is. An s corp’s revenue is not taxed at the corporate level. It is only taxed when paying out as salaries or dividends to shareholders. An s-corp is often a better choice than a c-corp for most small businesses.
It should also be noted that corporations have a lot of regulations regarding paperwork and documentation. This is not an entity for you if you want to be footloose and fancy-free.
Limited Liability Company (LLC)
Limited Liability Companies are extremely popular among many business owners because they often combine the best both worlds when it comes to liability and taxation.
These hybrids clear their owners of personal liability for the business’s debts or liabilities. They also allow the profits of the company to “pass-through” to the owner. An LLC will let you avoid the double taxations of corporations.
At the end of the day, you are the one who should decide what business entity best suits your needs. Make sure you consider important factors like taxation and liability. You should also go to your secretary of state’s website to find out what it takes to formally register your business.
Conclusion
Overall, limited liability companies are a great choice for most small businesses. They provide their owners with protections and avoid the double taxations of corporations.