From Our Partners at 1-800Accountant
Starting a business is hard work. If your small business succeeds, it will be built on your dedication and creativity. That's what being an entrepreneur is all about.
However, if you really want to give your business a fighting chance to make it, it will also require careful planning and preparation. You need to write your business plan. And the first thing you need to figure out for your plan is how business entities work.
Your business entity describes the official status and structure of your business before the law. Do you want your business to have its own separate legal status, or would you rather it just be an extension of yourself as an individual?
The business entity determines the chain of command and control of your business. Every business is an entity of one kind or another, so you need to be sure about what works best for your situation.
There is a lot you need to think about to help you pick the right entity for your business. Each business entity has different advantages and disadvantages, so you need to be clear on your own goals for this venture if you're going to make the best decision.
How much personal liability are you comfortable with? Some business entities give you more protection from possible debts, but protecting yourself may mean giving up some control over profits and important business decisions. Do you plan on making all the choices for your business, or are you hoping to work with a partner or even share control with shareholders?
You also need to consider what kind of tax status you want your business to have. Some entities function as pass-through entities, which means you get to file your business income directly on your personal tax return. Other entities may require filing their own separate business returns.
Here are the primary types of business entities you might consider:
Limited Liability Company (LLC)
Most small businesses in the United States qualify as sole proprietorships. If you don't officially file for another business status, your business automatically falls into this category. Anyone self-employed is technically operating as the sole proprietor of their own small business.
Sole proprietorships do not exist apart from you as an individual. This gives you maximum control as the owner, but it also leaves you with maximum liability if anything goes wrong. The tax paperwork you need to fill out will also depend on whether you have any other employees.
A partnership is a business entity that involves an operating agreement between two or more people or organizations. Often this means two general partners run a business together and share profits and liabilities.
Sometimes, however, one partner takes charge of the business's day-to-day operations, while the other—known as the limited partner—provides funding for an agreed-upon share of the profits.
C-corporation refers to any corporation with regular corporation tax status under U.S. law. A corporation is a distinct legal entity with its own status apart from any individual owner or operator.
Corporations sell their ownership in the form of stock. Shareholders of that stock may receive dividends, but they aren't liable for debts the corporation may hold. Operations of a corporation are managed by a board of directors elected by shareholders.
C-corporations pay taxes on their income reported on their business tax return as their own legal entity. Shareholders who then receive income through the corporation are then required to report that income on their personal returns.
S-corporations are legal corporations that file with the IRS for S-corporation tax status. This means that the IRS agrees to treat the corporation as a pass-through entity, allowing shareholders to file their portion of the overall business income directly on their own personal tax returns. This avoids the double taxation that C corporations face.
This option is usually only available to smaller corporations or those in their beginning phases. To file as an S corporation, a corporation must meet these specific legal requirements:
Must have a maximum of 100 shareholders.
Shareholders generally must be U.S. citizens or legal residents.
Must be a domestic corporation.
Can only have one class of stock.
A limited liability company is another business entity that is best understood as a hybrid of other business types. It offers the corporation's limited personal liability while still functioning as a pass-through entity like a partnership.
To create an LLC, you must file at the state level. For federal income tax purposes, an LLC will take on one of the other business entities' tax status.
If you know precisely what you want to do with your business and what you want it to become, it should be simple enough to find the right business entity for you. This is an important choice for the future of your company.
Take your time with this decision so that you don't regret it later. Consider working with an accountant to make sure you understand the stakes and work out the optimal path for your business endeavor.
No information contained in this post should be construed as financial advice from Web.com Group, Inc. Additionally, the information provided in this article is not intended to constitute legal advice.