What Type of Business Entity Am I?
Choosing the right structure can help you get the most out of your business. Your form of business will determine which income tax return you file and can change the destiny of your company. The most common business entities are Corporation, Limited Liability Company, General Partnership, Limited Partnership, and Sole Proprietorship.
Corporation
Corporations are split up into C-Corporations and S-Corporations. Both must file articles of incorporation within the state to become a corporation.
C-Corporations is the best suited format to take a company public, which means it is the best entity to attract investors. If your company is publically traded you have to file quarterly reports with the SEC (Securities and Exchange Commission) and be audited by an accounting firm. Downside, C-Corporation is the worst for tax purposes because you pay a double taxation. The corporation is taxed at the entity level and then the shareholders are taxed at the individual level.
S-Corporation has a limited number of shareholders. It is typically limited at 100 shareholders which means you cannot go public, but it also means that they are a lot more closely held. With a S-Corporation, you are only taxed once at the shareholder level and you don’t pay taxes at the corporate level, which is also called a flow through entity.
Limited Liability Company (LLC)
A LLC is unlimited in the number of investors. Which really means more money for you and your dreams. Every investor has limited liability to protect themselves and their personal assets. If the company defaults on its debt agreement, the bank, or whoever is trying to get the money back, can only get it from the LLC, not the investors and members of the LLC. This protects the investor’s personal properties. It is also nice because you can have a single member LLC. So instead of being a sole proprietor (keep reading, you’ll get there), you file articles of organization within the state to become a LLC. Typically as a sole proprietor you would be held liable for the debts of the company, but as a single member LLC you would not be liable for the debt. It is also a flow-through entity (only taxed at shareholder level).
General Partnership
This is the most basic form of a partnership. The court views any two (or more) people in business operation together as a general partnership. This means that neither partner has limited liability protection and that all partners can be held liable for the debts of the partnership. What makes a partnership advantageous is that you can delegate how the profits and losses flow through to the different shareholders. If one shareholder has a high tax bracket because of other sources of income, they can be allocated more of the loss. If another shareholder doesn’t have a high tax bracket, they can be allocated more share of the gain, meaning he would pay less taxes on it than another partner would.
Limited Partnership
Limited partnership is like the special version of general partnership. In a limited partnership there are both general partners and limited partners. General partners will usually manage the business and in some way dictate how the business runs. General partners can be held liable for the obligations and debts of the business, but limited partners cannot be. In order to be a limited partner, you can’t have a say in business decisions. Essentially, it is viewed as a passive investment for the limited partner. Your money is there, but your opinion is not. It is also a flow through entity (only taxed at the shareholder level) and has flexible arrangements in where profits and losses are allocated.
Sole Proprietorship
A sole proprietor is any one, individual doing business. There is no liability protection, no filing with the state, all profits and losses are on you, and you won’t see your name on the NASDAQ anytime soon. All businesses start as a sole proprietorship at some point.
When choosing your entity, make sure to take all of your legal and tax concerns into consideration and choose what will be best for you and your company. Still confused? Check out the simplified business entity chart below:
