Declaring a business entity is a necessary step in legitimizing your business. Your business entity tells the IRS how to tax your business. This is an important choice because the right entity can save you a great deal of money in taxes.
What type of entity will suit your company? This comprehensive guide will help you understand your options when choosing a business entity.
Sole Proprietorship
Becoming a sole proprietor is easy-just start doing business and don’t register as any other kind of business. You’ll be automatically considered a sole proprietor in regard to taxes.
Sole proprietorship gives you the most control over your business because you don’t share ownership with partners. You also have the most responsibility as a sole proprietor-your business assets and personal assets are not legally separate. This means you could be held personally liable for debts and other obligations incurred by your business.
Choose sole proprietorship if your business is low-risk, or if you want to test your business idea before locking into an incorporation.
Corporations
Incorporating is a good choice for medium to higher-risk businesses. It can be pricey to maintain (it currently costs $800 a year to own a corporation in California) but the added protection and taxation benefits are well worth it for many.
There are five types of corporations:
- Standard Corporation (C-Corp) – This is the most common type of corporation. They protect the owner from being personally liable for the actions and debts of the corporation. Corporations are taxed twice, once on it’s income at the corporate level, and again when that same income is distributed to shareholders. There are ways to avoid or minimize double taxation, through income splitting, retained earnings or salary distributions.
- Small Business Corporations (S-Corp) – These are taxed like a sole-proprietorship or partnership, with each owner paying tax only on the amount of their shares. This helps entrepreneurs avoid the double-taxation on a c-corp, but this option isn’t available to everyone. S-corps aren’t recognized in some states, like Texas and Louisiana.
- Limited Liability Company (LLC) – This type of corporate structure lets you take advantage of both the corporate and partnership entities. Registering as an LLC will separate your personal and business assets, while allowing you to include multiple owners onto your business.
- Non-Profit Organization – Declare your company as an NPO if you plan to do charity work, work in education, conduct scientific research or practice religious or literary work. If your business plan is to enrich the public rather than accumulate capital, this is the right business structure for you. Nonprofit corporations follow similar organization standards as a C-Corp, but instead file with the IRS to get exempt from paying taxes. As a result, nonprofits can’t distribute profits to members or political campaigns.
- Benefit Corporations – Arising from the “b-corp” movement, benefit corporations are currently recognized in 27 states. Benefit corporations operate for profit, but adhere to tenets of accountability, transparency and purpose in their business model. Alternatively, your business could operate under a more popular or available model and apply for a b-corp membership.
Partnerships
There are three types of partnerships: general, limited, and limited liability.
General partnerships (GP) are easy to create and have few ongoing requirements. With a business license.
Limited partnerships (LP) give unlimited liability to one partner, and other partners are limited to their investment in the LP.
A limited liability partnership is similar to an LLC corporate entity but differs in the taxation regulations.
After reviewing your options using this guide, we recommend meeting with a qualified CPA before declaring your entity. An accountant can help you make the best choice for you and your business.
