How to Choose the Right Type of Business Entity

The SunDoc Definitive Guide to Choosing the Right Business Entity

 

One of the first difficult decisions you have to make as a business owner is which type of entity to use. Choosing the entity type for your business has a huge impact on how it operates and how you’re taxed. Which one should you use for your business?

 

Here are the common choices - Sole Proprietor, LLC, Corporation and Partnership. Take a look at these types of business entities below, and the basics of each.

 

Sole Proprietorship

 

If you don’t elect a different type of business entity, you are a sole proprietorship by default.

 

Benefits:

  • No paperwork required for filing
  • Operate however you want
  • Taxes are relatively simple to file

Disadvantages:

  • You are legally responsible for any lawsuits filed against your business
  • You pay higher taxes because of the self-employment tax, when other entities (the S Corp) are more tax-efficient

If you are a sole proprietorship, take a look at our explanation of the useful DBA, “Doing Business As” designation.

 

Limited Liability Company (LLC)

 

The LLC is one of the newer types of entities you can form.

 

Benefits:

  • Legal liability for lawsuits is held against your company, while your personal assets are protected.
  • Unlimited number of owners.
  • You are not required to hold annual meetings or record their minutes (like you are with a corporation).
  • You can disproportionately split the profits and losses in excess of each individual’s ownership percentage (not possible with shareholders of corporations).
  • You can elect to be taxed as a S Corporation, whose profits are not subject to self-employment tax.

Disadvantages:

  • More paperwork required than a sole proprietorship (although it’s still comparatively minimal).
  • If you do not elect to be taxed as a S Corporation, all profits you get are subject to income tax.
  • The managing member must pay self-employment tax.
  • You have to recognize profits immediately (not required for corporations).
  • Fringe benefits (group medical insurance) are treated as taxable income (not necessarily required for corporations).

Learn how SunDoc can help you Create an LLC in any state.

 

Corporation

 

The two most popular types of corporation are the S Corporation and the C Corporation, each with advantages and disadvantages.

 

1. S Corporation

Benefits:

  • You can classify a reasonable amount of your income as salary, and some as a dividend distribution (which does not require you to pay self-employment taxes).
  • You are allowed to have up to 100 shareholders, as long as they are legal US citizens.
  • The legal and tax structure is separate from you the owner, which means your personal assets (and those of shareholders) are protected from lawsuits.
  • You often pay less tax than you would with a C Corporation.
  • Generally work well for small and medium-size businesses.

Disadvantages of S Corporations

  • You have to do much more paperwork and administration than you would with an LLC or sole proprietorship. This can include Articles of Incorporation, corporate minutes, shareholder meetings, and additional fees and paperwork, which vary by state.
  • You cannot have an unlimited number of shareholders like a C Corporation.
  • Fringe benefits (medical insurance for example) may not be deductible.
  • Shareholders are taxed for any income the company gets, even if they don’t receive that income themselves.
  • All officers and owners must make a salary, even if the company isn’t profitable.

2. C Corporation

Benefits:

  • You can have an unlimited number of shareholders with no restriction on selling different classes of stock (allows for rapid expansion).
  • Shareholders are not responsible for business debts.
  • Shareholders can have votes which count for more than others, making it easier for the company to make decisions and expand.

Disadvantages

  • The main one is possible double-taxation, which happens with C  Corporations because corporate income is taxed at the corporate level and dividends are taxed at a personal level.
  • Like S  Corporations, they require significant additional paperwork and administration(corporate minutes, shareholder meetings, and more which can vary by state).

Learn how SunDoc can help you file as a C or S Corporation in any of the 50 states.

 

3. Nonprofit Corporation

 

These organizations are set up with the idea of accomplishing a goal other than making a profit.

 

Benefits

  • You do not have to pay any federal or state taxes and are often exempt from many local taxes.
  • You can get public and private donations.
  • Like other corporations entities, you are personally protected from all liability.

Disadvantages

  • Nonprofits do require a fair amount of paperwork.
  • Not all businesses can become nonprofits. Generally, you must accomplish a mission or serve the public good in some way.
  • Directors cannot be paid.
  • Generally you may not campaign politically.
  • Nonprofits often have missions that are highly regulated by state and federal authorities.
  • When you close your nonprofit, you must give the assets to another nonprofit.

Strapped for time? Let SunDoc help you file as a nonprofit in any US state.

 

4. Professional Corporation

 

This entity is typically used by self-employed, licensed professionals such as an accountants, lawyers, doctors, etc - and sometimes mandated by a state for certain professionals. Each owner is protected from malpractice of any other owners within the company. PCs are typically taxed at a flat rate, which loses much of the flexibility of other types of corporation.

 

[Note there is also the Professional Limited Liability Corporation (PLLC), which taxes the owner at the lower LLC tax rate. This entity is available in all states except California.]

 

Benefits

  • Remove malpractice responsibility from any other owners within the entity from the primary owner.
  • PLLCs can be taxed at the lower LLC tax rate (versus the higher C  Corporations tax rate of a PC).

Disadvantages:

  • Not available in every state.
  • More paperwork than a sole proprietorship.

 

Learn how SunDoc can help you incorporate in any state, or call us at 1-888-595-2747 for live assistance.

 

Partnership

 

General Partnerships usually do not require state filings. A Partnership Agreement should be created. Two or more people can form a General Partnership and the length of existence depends upon the Partnership Agreement. There are few legal requirements. In terms of liability both business partners are equally responsible unless the Partnership Agreement states otherwise.

 

Benefits

  • You get to share the cost of startup and business responsibilities with a partner.
  • You can accomplish bigger and better things working together with another person.
  • Different types of partnerships can limit the personal liability of one or more partners.

Disadvantages

  • You are responsible for all business debts and actions of the other partner.
  • You have to share the profits.

There are two other types of partnership, Limited Partneship and Limited Liability Partnership. See which is right for you in our article, What Kind of Partnership is Right for You?

 

If you’re ready to set up a partnership, SunDoc can help you:

 

For a simple comparison of all entities on one page, check out our Entity Comparison Table.

 

 

 

 

 

Disclaimer:

SunDoc Filings is not a law firm.  The materials available at this web site are for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem.