CHOOSING THE RIGHT BUSINESS ENTITY FOR YOUR COMPANY

(Not intended for a legal audience)


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Congratulations! You’re about to embark upon the journey of entrepreneurship. You’re excited, but you don’t know which entity structure to select for your business. Your decision on business structure can have an immediate and significant impact on your business as well as a lasting impact on your ability to raise capital. The legal structure that you select will determine everything from how you pay taxes, the amount of paperwork involved, and the impact of a lawsuit.


This post should help to clarify many of those points. After reading this post, you should be more enlightened about the advantages of the various business structures and the tax implications of those structures. Here are some key points to consider as you proceed in your journey of entrepreneurship.


Types of Business Entities and Tax Treatment


Most for-profit businesses are generally formed under state law as:

  • Sole Proprietorships

  • Partnerships

  • General Partnerships

  • Limited Partnerships

  • Limited Liability Partnerships

  • Corporations

  • Limited Liability Companies


For tax purposes, a business entity is treated as one of the following:

  • Disregarded entity – Pass-through taxation

  • C-Corporation

  • S-Corporation

  • Partnership


SOLE PROPRIETORSHIP


A sole proprietorship is the simplest form of business to launch. A sole proprietorship can operate under the name of its owner or it can do business under a fictitious name (commonly referred to as a “DBA” or “doing business as”). There are no formal requirements to establish this business structure. Thus, it is not necessary to file any documents with the state or the IRS. Although, some states require that you register the fictitious name with the secretary of state’s office. This particular business structure is only available to married couples or individuals. There are no partners, shares, or membership interests in a sole proprietorship, which generally makes it difficult to attract investors without first changing the business structure. The biggest disadvantage of sole proprietorships is that the owners are not legally separate from the business. Therefore, the proprietor is personally liable for all debts and obligations of the business. If the business is sued, personal assets such as your savings, house, car, etc. are at placed risk.


Tax Treatment


A sole proprietor is required to report all business income and losses on their personal income tax returns; the business entity is not taxed separately. This tax treatment is commonly referred to as "pass-through" taxation because business profits pass through the business (avoiding corporate taxation) and are taxed on the business owner’s personal tax returns.


A sole proprietor does not have an employer to withhold income taxes from their paycheck. The proprietor must estimate how much tax will be owed at the end of each year and make quarterly estimated income tax payments to the IRS, and if required, to their state tax agency.


SOLE PROPRIETORSHIP AT A GLANCE


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PARTNERSHIP