When an entrepreneur begins a for-profit business, one of the key early questions he or she needs to answer is, “What kind of business structure will serve me best?”
How should the business owner decide on the correct entity?
Making the final choice with regard to business entity usually involves weighing the answers to the following questions:
Which kind of entity allows me to operate most efficiently?
What entity choice will provide me maximum protection from the liabilities I am worried about?
Which choice is the smartest from a tax perspective?
Here is a quick overview of the most popular types of business entities, and how they stack up based on those three factors:
A Proprietorship, sometimes called a sole proprietorship, is simple to operate and its tax results are reported on the personal tax return. Its owner is responsible for all debts of the business.
A Partnership involves more than one business owner. While there are more hands available to do the work than a proprietorship, it is more complicated to operate because there need to be rules about how decisions are to be made and how finances are to be handled. All the partners are liable for all the partnership debts. The business’s tax results are reported on a separate tax return, but the results are passed through to the partners personally.
A Limited Liability Company (LLC) provides its owner(s) better liability protection than a proprietorship or partnership. It also needs written rules about how it will be operated. An LLC can have the tax characteristics of any one of the other entities listed here, depending on the choice the owner(s) make.
An S-Corporation offers the tried-and-true liability protection of a corporation with pass-through tax results similar to those offered by a partnership. Corporations need a set of rules – called by-laws – on how it will operate.
A C-Corporation is a more traditional corporate structure, offering the same kind of liability protection as an S-Corporation. It differs from most of the entities listed here, in that it has a separate tax identity from its owner(s). In some cases, the separate tax entity offers certain kinds of tax management advantages. Also, certain kinds of employee benefit plans create more favorable tax results in a C-Corporation.
If you are considering starting a business, you will need to get advice about your situation from an attorney and CPA. If you do not already have an attorney, I will be glad to counsel you on the legal elements involved.
If you are already operating a business entity, you should check with a CPA and an attorney to make sure your entity choice is still right for you. Also, feel welcome to call on our office to make sure that you are taking full advantage of the tax breaks offered to owners of a business of your type.