A business entity is the legal designation of an organization’s structure. If you are planning to launch a venture or just want to start a side-hustle, picking the right business entity is critical.
There are several different types of business entities:
- Sole Proprietorship
- Limited Liability Company (LLC)
The entity you pick can affect your taxes, your personal liability, your ease of raising capital, and the amount of annual paperwork, among other things. Picking the right structure for your business is critical. Therefore, you should conduct independent research and contact a local CPA for more guidance when it comes time to selecting your entity and completing the appropriate legal documentation.
To help you understand business entities better, consider the guide below.
A sole proprietorship is the most popular business entity because it’s the easiest to form. Simply put, it’s a business ran exclusively by the owner. It’s unincorporated, meaning there is no legal separation between you and the business. In fact, if you are performing business activities and haven’t formed another business entity, you are considered a sole proprietor.
Sole proprietorships offer owners complete control and autonomy of all business decisions, but they are not without risks. Sole proprietors are legally responsible for all liabilities and debts incurred by the business. This means that are personally liable for all financial or legal obligations of the business.
From an accounting perspective, you will need to separate financial activities of the business from your personal finances. This includes business and personal income and expenses. You’ll need to report your business gains or losses separately on your tax return as the IRS uses “pass-through” taxation to tax sole proprietors.
If you want to start a small business with limited expenses and liabilities, a sole proprietorship could be the best business entity.
A partnership is a business entity formed by two or more people or businesses. Partnerships are popular business structures because they typically make it easier to raise capital and provide more available resources.
Within a partnership, you can pick between two subsequent designations.
Limited Liability Partnership (LLP)
As the name suggests, a limited liability partnership is unique in that it affords legal protection to all owners. The debts and obligations of the partnership do not extend to the partners.
Limited Partnership (LP)
Unlike an LLP, limited partnerships do have partners with unlimited liability, meaning they can be personally held responsible for the business obligations. However, LPs also have other partners with limited liability. In most cases, the partners with unlimited liability have more authority than the limited liability partners – although, that’s designated by the partners.
Partnerships are designed to create a distributed structure by which all owners contribute to areas of the business like capital expenditures, labor, property, and leadership. Moreover, the profits and relevant liabilities are also split similarly among those same partners.
If you are considering going into business with another person, professional, or business, a legal partnership may be a wise choice.
Corporations are business entities that receive a certificate of incorporation and are considered legally separate from its owners. Corporations are legally liable for debts and activities, and corporations can be taxed. Corporations provide its owners the most protection of all entities, but they do require more documentation, record-keeping, and reporting.
There are a few different options for the structure of your corporation, but the two most popular are C Corporations (C Corps) and S Corporations (S Sorps).
The main difference between a C Corp and S Corp is how they are taxed. A C Corp has what is known as double taxation on its profits. It is taxed once the company earns a profit and again when the shareholders receive dividends on their personal tax return. An S Corp is able to avoid double taxation by passing profits and losses through to the owner’s personal income tax return.
Corporations are very popular business structures because of the protection they provide owners. They also make it easier to raise capital through the selling of shares.
If you plan on growing a medium-to-enterprise business, then you will want to strongly consider forming a corporation.
Limited Liability Company (LLC)
A limited liability company (LLC) is another popular business entity for small to medium-sized businesses. It’s a hybrid business structure that includes several of the benefits of other entities like a corporation and partnership.
Owners of an LLC receive many of the legal protections that corporations do, while also enjoying the tax benefits and flexibility of a partnership. An LLC’s owners are referred to as “members,” and they are able to pass the business’s profits and losses through to their personal federal tax returns.
LLCs are established at the state level and may have different requirements depending on where you operate. Therefore, it’s important to contact a local business advisor with experience with business entity structure and formations.
Forming a limited liability company can be a wise choice if your business is in a high-risk industry or you want to take advantage of the tax breaks and limited liability an LLC offers.
If you are planning to start a new business, you’ll need to decide what type of structure you want. Because there are several advantages and disadvantages to each entity, it’s critical that you do your own research and contact a professional if you still have questions or want help completing the required formation documents.
To learn more about business entity formation, contact Rivero, Gordimer & Company’s team of certified public accountants today!