When starting a business, there are many issues to consider.. One of the most important is which type of business entity your business should employ. There are several different options, each of which will have implications on the legal structure of the business, the taxes it will owe, and much more.
Taking some time to learn about the most common options, and how they will impact you today and in the future, is a helpful way to decide which business entity is right for you. Of course, talking to an experienced business attorney is also helpful in order to sort out your options when starting or growing a business.
A sole proprietorship is owned by an individual, and is typically established with a simple filing using the individual's name “doing business as” (DBA) the business name. With this option, the business and the business owner are essentially one entity. This means the business owner will not have any legal protections against liabilities created by the business, and he or she they will be liable for all the debts and other legal liabilities of the business. All the profit from the business is also going to be seen as direct income to the individual, and must be reported on his or her personal income tax return.
A partnership is fully owned by two or more people who legally agree to share both the profits and losses of the business. While it isn't always legally necessary, it's always prudent to have such an agreement in writing. Similar to a sole proprietorship, the liabilities of the business will land on the shoulders of the partners. The profits and losses are passed through the business to the individual income tax returns of the owners, which has some important advantages to many people, including the fact that any income is only taxed once. An additional risk compared to the sole proprietorship form is that either partner can create liabilities within the scope of the business that apply to all partners – even if the other partners didn't know about them.
A corporation is a legal entity that is separate and distinct from the founders or current owners. There are two types, based on how they elect to be treated for income tax purposes. The first is the “C Corporation”.
From a tax perspective, the corporation is taxed on its earnings, and is essentially treated as if the corporation itself is a person separate from the owner or owners. The most significant benefit of a corporation is that if it is properly formed and operated it is liable as an entity for any damages or obligations of the business, not the owners. This feature provides the owners with a significant layer of protection from personal liability.
One disadvantage, however, is that the profits of a corporation are taxed at the corporate level, and any dividends paid to the owners are also taxed at their level. This results in double taxation of the profits passed through as dividends.
The second type of corporation based on tax effects is an “S Corporation”. S Corporation status can be chosen for income tax purposes for a corporation that meets certain legal requirements, . Generally speaking, this option offers the liability protection benefits of a corporation while allowing income and losses from the business to pass through to the owners and be taxed only at their level.
Limited Liability Company
A limited liability company, or LLC, was designed to bridge the gap between partnerships and corporations. This option allows business owners to limit their personal liability, while still having the income pass through to the owners without taxation at the company level. Income is taxed only at the individual level. The company ownership can also be more complex than is typically associated with a partnership.
Choosing Your Business Entity
This is just a brief introduction to the most common types of business entities. When looking to start your business, it is important to have an attorney review your situation and advise you on the options and help you determine which will offer the most benefits. Please feel free to contact The Law Office of Philip P. Crowley, LLC to discuss all your options.