It’s exciting to start a new business. The initial excitement is followed by a decision making phase where you have to decide which entity type your business belongs to. The entity type that you choose greatly affects the way you operate, so it’s important to know what suits you best.
A business entity type defines the legal structure of your company. The type you choose will determine:
- The tax to be paid if your company comes under any kind of litigation.
- The growth potential of the organization.
The U.S. government recognizes sole proprietorship, general partnership, limited partnership, C corporation, S corporation, and Limited Liability Company (LLC) as the major entity types under which businesses can be classified. Let us look at each one of them in detail.
1. Sole Proprietorship
- Sole proprietorship comes into effect as soon as you start selling your products or services.
- This form of business entity has a single owner and all financial responsibility and legal liability lies with him/her.
- The business’s expenses and returns are recorded in the owner’s personal tax documents.
- There are no registration formalities involved here.
2. General partnership
- General partnership automatically comes into effect upon commencing your business operations.
- The business is owned by more than one person and does not require any formal registration process.
- All founders bear equal liability in case any legal action is taken.
- Profits and losses are reported on personal tax documents.
3. Limited Partnership
- The difference between a General Partnership and Limited Partnership is that the owners have little to no liability.
- Forming this type of business entity does not entail owners to follow any formal registration process.
4. C Corporation
- This form of business entity offers limited liability protection for owners, so they are not responsible for any of the business’s debts or liabilities.
- Owners need to follow a formal registration by filling out documents such as Certificate of Incorporation with the state.
- In this entity type, shareholders are the owners. They elect the board of directors to oversee its operations.
- C corporation owners are taxed twice – for business and personal earnings from company dividends.
5. S Corporation
- S corporations have all characteristics of C corporations except that they are not taxed twice.
- It is imperative to file form 2553 with the IRS to register for an S corporation.
- This entity type is limited in its ability to grow since number of shareholders is limited to 100.
6. Limited Liability Company(LLC)
- If you choose LLC as your business entity type, then you have the flexibility of choosing how the business will be taxed.
- Here, profits and losses are listed on the personal tax return documents of the owners.
- LLC is a highly flexible business entity form that is preferred by many small business owners.
- The regulation to file under LLC varies from state to state.
Choosing the right entity type for your business can determine its future course of action when you plan to expand your operations. Irrespective of the type you choose, accounting and bookkeeping are vital to successfully track and manage your finances. SmartFin is a leading partner with over ten years of experience in providing end-to-end accounting and bookkeeping services. If you would like to explore how our services can be of help to you, send us a line and our experts will get back to you.