How to Choose the Best Entity Type for Your Business

You’ve spent a lot of time thinking about your business. You have your business plan, you are prepared for each step of your process, and you have even started to talk to potential customers about what you can offer them. The last to-do item on your list is to register your business with the state and choose your entity type. As easy as this sounds, many businesses struggle to choose the correct entity type for their business needs.

Sole Proprietorship

The sole proprietorship is a popular choice for small businesses early in their business life. Many business owners use the sole proprietorship as an opportunity to test their business idea before entering a more formal business structure. This is also an excellent option to choose if you are a business with low risk.

Caution should be taken before choosing a sole proprietorship because business owners can be held personally liable for any business debt or legal obligations.  This entity type does not provide personal asset protection from lawsuits or bankruptcy related to the owner’s business.  The business activity for the year is filed with the owner’s personal tax return.

Partnership

If you are starting your business with another person, a partnership may be a great option for you and your co-owner. The two most common types of partnerships are limited partnerships (LP) and limited liability partnerships (LLP).  The activity for partnerships is filed on a partnership tax return.

LPs identify one general partner with unlimited liability, while other partners have limited liability. The general partner may be personally responsible for any debts or obligations of the business, but this also grants them more control in business decisions. The partners with limited liability are not personally responsible for business debts or obligations, but also have limited control over business operations and decisions. These partners may also have to pay self-employment tax. All details of the limited partnership should be outlined in your partnership agreement.

LLPs assign limited liability to all partners, protecting all individuals against the obligations and debts of the business.

Single Member Limited Liability Company (SMLLC)

The structure of the SMLLC separates business assets and personal assets. Individuals who have significant personal assets choose the LLC to protect their assets from seizure in the event their business is bankrupt. Many small businesses choose the SMLLC as it allows the owner to file their business activity with their personal taxes without facing the cost of preparing a separate business return.

Limited Liability Company (LLC)

This entity structure is similar to a partnership when there is more than one owner, also called a member.  LLC’s can be member-managed or manager-managed, depending on how involved the members are in the operations of the business.  A separate tax return is filed like a partnership and member’s personal assets are protected, same as an SMLLC.

Corporation

Choosing a corporation entity for your business legally separates the business from you and any other owners. There are several types of corporations to choose from:

C Corp

Although the cost to form a C Corp is higher than other structures, it provides the most protection to the owners’ personal assets. Corporations must pay income tax on their profits and are required to submit extensive records and reporting, including a corporate tax return. As businesses grow, many owners choose the C Corp entity, as it allows the sale of stock to raise capital, and currently, C Corps have a preferential tax rate.

S Corp

The S Corp allows business profits to be passed through the owner’s personal income without being subject to corporate tax rates.  Owners enjoy the same protection of personal assets as a C Corp.  S Corps are more flexible than C Corps in getting money out to owners.  Overall, S Corps do not have the same double taxation as a C Corp at the corporate and personal levels when certain transactions occur in the C Corp.

Choosing an entity type for your business is a crucial step in legitimizing your business. If you have further questions regarding which entity type is the best fit for your business, please reach out to the Anderson ZurMuehlen team.

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