A sole proprietorship is the type most often chosen when it comes to business entity. It’s easy to begin and offers control to the owner. However, the owner is also personally liable for all financial obligations of the business.
A partnership involves two or more people who agree to share the profits or losses of a business. One advantage of this type of business entity is that the partnership does not bear the tax burden of profits or the benefit of losses—profits or losses are “passed through” to the partners to report on their individual income tax returns. A disadvantage is liability—each partner is personally liable for the financial obligations of the business.
A corporation is a legal entity created to carry out business. It becomes an entity apart from those who founded it that handles the responsibilities of the organization. Like a person, a corporation can be taxed and held liable in court for its actions. It can also make a profit. Perhaps the most desirable benefit of this type of legal structure is the avoidance of personal liability, but a big disadvantage is the cost of the business entity and the quantity of record-keeping required. Double taxation is occasionally identified as a drawback to incorporation, but the S—or Subchapter—corporation (a popular variation of the regular C corporation) avoids that by allowing income or losses to be passed through on individual tax returns, similar to a partnership.
A limited liability company or LLC, is a hybrid form of partnership gaining in popularity because it allows owners to take advantage of the benefits of both the corporation and partnership forms of business. Advantages of this type of business entity are that profits and losses can be passed to owners without the business itself being taxed, while the owners are shielded from personal liability.
View a chart of the options and factors involved in selecting your business entity.
As mentioned at the start, sole proprietorship is the most popular choice for a business entity. This is perhaps because it’s so easy to begin making money, but it also exposes the owner to unlimited personal liability and precludes raising money from investors; the corporation and LLC provide limited liability protection. On the other hand, if you think that recognizing business profits and losses on your personal return is best for you, or if you wish to avoid double taxation, consider the S Corporation or LLC forms.
If you’d like help determining the right entity to save you money on your taxes, give us a call. No matter what you choose, you’ll want to meet with your financial planner, accountant, and lawyer to make sure things fall into place.