So you’re thinking about starting a business… congratulations! Along with legally starting your own business comes a lot of exciting decisions and opportunities. While some choices are fun and exciting, others are more strategic and logistic. Filing for your business entity type is one of the decisions that require a little more thought and a little less room for interpretation.
How do you know what business type is right for you? It’s actually not as complicated as you may think. Depending on your business’s current status and plans down the line, it should become fairly clear which business type is right for you. And if it’s not, well, that’s what we’re here for!
Sole proprietorships are the simplest and most common form of business ownership. These are businesses that are owned and run by someone for their own personal benefit. The business’ existence is fully dependent on the owner’s decisions, so when the owner ends their services for any reason, the company ends, too.
Advantages of sole proprietorship:
- All profits go directly to the owner
- There are very few regulations
- Owners have total flexibility when running the business
- Very few requirements for starting the company
Disadvantages of sole proprietorship:
- The owner is 100% liable for business debts and risk
- Equity is limited to the owner’s personal resources
- The ownership of a proprietorship is difficult to transfer
- Can be difficult to distinguish personal and business income
Partnerships fall into two categories: general and limited. Both owners invest their money, property, labor, and other assets to the business in a general partnership and are both 100% liable for business debts. In other words, even if you invest a little into a general partnership, you are still potentially responsible for all its debt. General partnerships do not require a formal agreement — partnerships can be verbal or even implied between the two business owners.
Limited partnerships require a formal agreement between the partners and are more binding than a simple handshake or conversation. These types must also file a certificate of partnership with the state. Limited partnerships allow partners to limit their own liability for business debts according to their percentage of ownership or investment.
Advantages of partnerships:
- Shared resources from partners provide more capital for the business
- Each partner shares in the profits of the company
- Similar flexibility and simple design of a proprietorship
- Inexpensive to establish and start a business partnership
Disadvantages of partnerships:
- Selling the business is challenging and requires finding a new partner
- The partnership ends when any partner decides to terminate it
For tax purposes, corporations are separate entities and are considered a “legal person.” This means that the profits generated by a corporation are taxed as the “personal income” of the company, and then, any income given to the shareholders are taxed again as the owners’ personal income.
Advantages of a C-Corporation:
- Limits the liability of debts or losses to the owner
- Profits and losses belong to the corporation
- These can be transferred to new owners fairly easily
- Personal assets cannot be seized to pay for business debts
Disadvantages of a C-Corporation:
- Corporate operations can be costly to start and maintain
- Start a corporate business requires complex paperwork and often third-party involvement
- With some exceptions, corporate income gets taxed twice
For some businesses, an S-Corporation may make more sense to register as than a C-Corporation. The biggest difference between C and S corporations is how taxes get filed.
A C-Corporation pays tax on their main income and on whatever income they receive as an owner or employee. An S-Corporation doesn’t pay business taxes. Instead, the owners report the company revenue as personal income.
Advantages of an S-Corporation:
- Single layer of taxation
*For small business owners evaluating S-Corps versus C-corps, the decision is usually based on how they want the corporation to be treated for federal income tax purposes.
Limited Liability Company (LLC)
Like a limited partnership, an LLC provides owners with limited liability while providing some of the income advantages of a partnership. Essentially, the benefits of partnerships and corporations are combined in an LLC, mitigating some of the disadvantages of each.
Advantages of an LLC:
- Limits liability to the company owners for debts or losses
- The owners share the profits of the LLC without a double-taxation
Disadvantages of an LLC:
- Certain state laws limit ownership
- Agreements must be comprehensive and complex
- LLC startup costs are high due to legal fees and filing fees
Filing For Your Business
Has it become clear to you which business type is the best choice for you? If not, we recommend talking to a professional like our team at Gift CPAs to learn more about each type and how a certain filing status can influence your business down the line. To schedule a conversation with our team, you can start here!