Business Entity Types:
How to Choose the Right Business Entity?
Do you know every business has an “entity type”, and each type has a different structure when it comes to taxes, assets, and liability protection? The choice of business entity is a monumental step for a new company, and you might wonder what’s the best type of business entity you can follow. Let’s look at the most common business entity types and see what can be the most applicable for your business.
The four most common business entity types
In a sole proprietorship, one person owns and runs the business. The owner is responsible for paying taxes, debt, and liabilities. In addition, owners must report profits and losses on Schedule C of their personal tax return. If you decide to run a small operation with few employees, then it would be the best route for you to start as a sole proprietor.
Pros of Sole proprietorship
- Sole proprietorship is the most affordable and least expensive to set up.
- It does not require any paperwork, apart from local licenses and permits.
- Sole proprietor’s income is taxed as personal income. Therefore, you must report your business profit and losses on your own personal tax return.
Cons of Sole proprietorship
- As a sole proprietor, you are 100% liable for the company’s finances. If anything happens to your business or someone’s hurt on your property then you are personally liable for all business expenses and debts.
- It can be difficult to raise capital as a sole proprietor because banking institutions and lenders see it as a riskier endeavor.
Limited liability corporation (LLC)
Limited liability corporations are considered a hybrid legal entity where owners can choose how they are taxed whether as a sole partnership or as a corporation. So, if you are looking for a legal structure that is easy to set up then you may choose LLC.
Pro of limited liability corporation
- Owners are not personally liable for the business’s debts or liabilities.
- There is less paperwork and lower filing costs in limited liability corporations.
Cons of Limited liability corporation
- It is more expensive to create an LLC because it requires high renewal fees (depending on the state).
- If one of the partners wants to leave, then you will have to dissolve the LLC.
This is the most common form of corporation in the USA. In C-corporations, there is no restriction on how many people and who can own shares.
Pros of C- corporation
- C- corporation offers limited liability to their owners. So, they are not entirely liable for the business’s debts and liabilities.
- Owners can issue stock which can help them to raise money in the future.
Cons of C- corporation
- C- corporations face double taxation- the business pays taxes on entity-level profits and then shareholders pay tax on dividend distribution.
- There are some formalities that corporations have to meet, such as creating bylaws, holding board and shareholder meetings, and keeping meeting minutes.
An S- corporation can only have 100 shareholders who must be U.S. citizens or residents. The difference between
C corporation and S corporation is S corporation does not pay taxes on income at the corporate level, instead only the
shareholders pay taxes on their profits.
Pros of S- corporation
- Like C- corporation, owners are not entirely liable for the business’s debts and liabilities.
- No double taxation because profits from the S- corporation pass-through entities with no corporate income tax.
Cons of S- corporation
- There is a limit when it comes to issuing stock.
- Unlike C- corporation, the IRS pays more attention to S- corporation to make sure that everything is reported on the tax return. If procedures are not followed, then owners may lose their S- corporation status.
How to choose the best business entity type
Choosing the right business structure is the most important part of running a business, even though it is not always easy to decide which structure to choose. However, with a better understanding of how the business entity types work, you may determine now which types of business structure can be best for your business. Moreover, it would be better to consult a business lawyer or tax professional for getting proper guidance on choosing which structure is optimal for you.