One of your first important decisions 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.
What is a business entity?
A business entity is a corporation created by one or more natural persons to hold on a trade or business.
The following are types of business entities:
- Sole proprietorship: Unincorporated business with one owner or jointly owned jointly owned by a marriage
- General partnership: Unincorporated business with two or more owners
- Limited partnership: Registered business composed of active, general partners and passive, limited partners
- Limited liability company: Registered business with limited liability for all members
- Professional limited liability company: LLC structure for professionals, like doctors and accountants
- C-corporation: Incorporated business composed of shareholders, directors, and officers
- S-corporation: An Incorporated business that is taxed as a pass-through entity
- Professional corporation: Corporate structure for professionals, such as doctors and accountants
- B-corporation: For-profit corporation that is certified for meeting social and environmental standards
- Nonprofit: Corporations: Formed primarily to benefit the public interest rather than earn a profit.
What is personal liability?
Personal liability means that your personal assets are 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 business.
If your business 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 business decisions and profits. You will also only be taxed one time on all business profits.
The greatest disadvantage of a sole proprietorship is that there is an unlimited liability. This means that you will be held personally responsible for all the 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 business and are okay with there being no formal division.
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 business is unlimited. Each partner is ‘jointly and severally’ responsible for the partnership’s debts; that’s , each partner is responsible for their share of the partnership debts also as being liable for all the debts of the business. This means that you can be held responsible for your partner’s neglectful actions.
If you are someone who enjoys working with a team and does not want to shoulder all the responsibility for the business 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.
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 business is run. They have limited liability concerning a business’s debts and they usually pay fewer taxes regarding the profit. The limited partners can be looked upon as silent investors.
If you want to retain primary authority in your business but definitely could use some other sources of cash than a limited partnership would be a great compromise.
A C-corporation (c-corp) is when the business is considered separate from its owners and operators. 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. First, the corporation is taxed as a separate entity and then you are again taxed on the profits in your own personal taxes.
This is a great model for those who really want to start a business 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.
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. That means that 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 you to actually choose whether you want your LLC to be taxed as a partnership or as a corporation.
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.
If you are a retail business you should also be aware that resale certificates are also a great way to save on taxation. A retail certificate allows you not to pay sales tax on items that you plan to resell. Please read our article, Everything You Need to Know About Tax Resale Certificates to find out more. Then let the experts at our site guide you through this confusing process so your business can be as profitable as possible.