business entity

The 4 Major Business Entity Types: What You Should Know

The American dream begins with “now open” but it could end on a sour note if you’re not careful. There are many ways to run a business but it is important to choose the one that fits your needs. As a new business owner, among other business entity types, you have the option of creating an LLC, a sole proprietorship, a corporation, or a partnership.

But before you pick and choose one of the four, you’ll want to understand the “makeup” of each business type. For tax purposes and for other important reasons – you should weigh the pros and cons of each business filing.  For the sake of brevity we are not providing an exhaustive discussion on each entity type. We will, however, highlight some of the major benefits of each business entity type.

LLC  

The Limited Liability Company (LLC), is what many small business owners opt for. Although it is not a corporation, LLCs have proven to be much more flexible than your standard corporation, in many cases. For example, single-member LLCs, that is, a company with one owner, is typically a “pass-thru” entity, which means that the revenue of the company is not taxed twice, as with corporations.  Instead, such business revenue is accounted for on the owner’s personal tax return, thus being taxed once. This is often very appealing to business owners.

One other major advantage of the LLC is that the owner is limiting her liability with respect to many mistakes and other problems that may arise. The LLC is designed to separate your personal status and assets from many business liabilities.  Between this protection and the tax advantages discussed above, many business owners choose an LLC. 

Sole Proprietorship

Oftentimes, most entrepreneurs start out as sole proprietors. If one says they are in business, starts offering a service or product to consumers, they are in business, period – and nothing more. You can provide that service and product and start making money.  While the simplicity of this entry into the business ownership may be appealing, be careful! This informal business startup has its risks, particularly when it comes to liability protection. With sole proprietorships, all activity and products of the business are likely tied directly to the owner – personally!  It’s an easy way to get started, but its risks are great! 

Corporation

Corporations may be the most commonly known business entity.  There are multiple pros and cons to a corporation. For now, let’s look at two of each:

Pros –

(a) Similar to LLCs, corporations typically provide liability protections in many cases, for much of the activity of the business.  This provides a sense of relief and peace for business owners; and
(b) Although corporations do provide a sense of double-taxation for business finances (more on that later), depending on the total amount of profits for the company, corporations may provide a tax advantage for the business owner. 

Cons  –

(a) As suggested above, for newer business owners, income of a corporation will be taxed at the corporate level (the corporation must file its own tax return), and then the income paid out to the owner will be taxed on her personal tax return. This means that the money is being taxed twice.   

(b) Corporations carry many requirements for meeting, documentation and business operations. In addition, corporations typically require much more paperwork than other business entity types.

Ultimately, corporations provide many benefits, but the requirements and burdens of corporations can cause corporations to be less appealing.

Partnerships 

A business-engaging agreement between two or more parties — be it written or oral — equals a partnership. With a partnership comes obligations for each partner. This may or may not be a benefit.

First, a written agreement, while highly recommended, is not required for a partnership. This alone could lead to conflict; one partner might not pull his or her weight, while another partner may have too much equity at stake to continue working as a partnership. There is a major trust factor as you are not just looking out for your own interests. Partners cannot compete with the partnership as a solo entrepreneur. No partner can compete with the business of the

Partnerships should include people who complement each other. There is nothing worse than being in business with someone who does not share the same vision as you. Be sure to communicate — not only with the partner(s) but with an attorney — to make sure all parties involved are mutually benefitting from the partnership. 

With this article we have shared information about four major types of business entities. For more information, you should contact our office to understand which business entity type works for you.

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