So you’ve decided to start a company. That’s great! What happens next? Unfortunately, the process isn’t as simple as making your product or service and selling it, and if you don’t check some of these boxes, it could land you in hot water before you know it.
Luckily, Small Business Nation is here to help. In our “Starting a Business” series, we’ll walk you through some of the less obvious steps so that you can start your business with confidence.
Before you set up shop, one of the most important decisions that you’ll have to make is what kind of business entity you should use. Business entities are legally recognized organizations that correspond to specific parts of the tax code. Each type of entity has specific rights, obligations, advantages, and disadvantages - many of which aren’t obvious. It can get complicated fast, so use our breakdown to make sure you’re making the right call on this foundational decision. Keep in mind that this is not legal or tax advice, so talk to a lawyer or accountant if you have questions.
LLC - Limited Liability Company
What types of businesses use LLCs?
A variety of types of businesses can use LLCs. Typically, banks and insurance companies cannot register as LLCs. However, LLCs are regulated differently in each state, so check out your state’s rules.
What are the advantages of LLCs?
- Fewer management and administrative requirements; no requirement to have a board of directors, etc.
- Your LLC may have unlimited owners (referred to as “members”)
- You do not have personal liability for business liabilities
- You may choose to be taxed once or twice
What are the disadvantages of LLCs?
- There are ongoing filings and fees to stay in compliance with state regulations
- You cannot take an LLC public
- If you do business overseas, some companies may recognize your LLC as a corporation
How LLCs are taxed
- You may choose to be taxed once or twice
Visit the IRS website for more information on LLCs.
S Corp
What types of businesses use S Corps?
A variety of types of businesses can use S Corps.
What are the advantages of S Corps?
- You do not have personal liability for business liabilities
- Single layer of taxation - only shareholders are taxed on distributions
What are the disadvantages of S Corps?
- S Corps are only permitted to have 100 shareholders
- Owners can only receive common stock
- More management and administrative requirements: must have a board of directors, must hold meetings and keep records
- All shareholders must be U.S. citizens or residents
How S Corps are taxed
- Shareholders report the flow-through of income and losses on their personal tax return
Visit the IRS website for more information on S Corps
C Corp
What types of businesses use C Corps?
Typically, businesses that want to bring on investors or have the opportunity go public one day.
What are the advantages of C Corps?
- Can go public
- Owners can have preferred stock (which typically are prioritized for dividend versus common stock)
- The number of owners is unlimited
- The entity type is recognized internationally
- You do not have personal liability for business liabilities
What are the disadvantages of C Corps?
- Double taxation: the corporation is taxed once and shareholders are taxed on distributions
- More management and administrative requirements: must have a board of directors, must hold meetings and keep records
- Regular fees and filings to stay compliant
How C Corps are taxed
- Double taxation: the corporation is taxed once and shareholders are taxed on distributions
LLP - Limited Liability Partnership
What types of businesses use LLPs?
Typically, professional service organizations (like law firms, consulting firms, etc.)
What are the advantages of LLPs?
- Limited personal liability: only liable for your own personal negligence
- Only taxed once
What are the disadvantages of LLPs?
- Less flexible management: management split equally between partners
- Limited personal liability: not completely protected from business liability
- Different states have different rules, so you will have to stay on top of those rules if your business operates in multiple states
How LLPs are taxed
- Profits are passed through to partners, who report profits on their personal income tax returns
Visit the IRS website for more information on LLPs.
Sole Proprietorship
What types of businesses use Sole Proprietorships?
Simple, one-person businesses where the business owner does not intend to take outside investors and is not seeking liability protection.
What are the advantages of Sole Proprietorships?
- Easy to set up - no paperwork (though you may need a DBA or a license, depending on the type of business and where you intend to operate)
- Taxed once - no separate tax return needed
What are the disadvantages of Sole Proprietorships?
- No personal liability protection
- Only allowed to have one owner
How Sole Proprietorships are taxed
Pay on profits from the Sole Proprietorship on your personal income statement.
Conclusion
As you can see, there is no one-size-fits-all answer to the question of what kind of business entity you should use. Weigh the type of business you intend to operate, your risk tolerance, how you want to operate the business, and the regulations in your state and make an informed decision.
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