Starting a business can be exciting, challenging, and stressful. There is a ton of things to do and what feels like very little time to do it all. However, despite the crowded agenda, there is one part that requires a patient hand. It is prudent for any new business owner to look into how they are going to structure their business. This typically involves filing paperwork with the local state and the IRS. Choosing the correct entity status can make a huge difference in how the business is run. The structure of the business can also control the taxes that are paid in the business. Each different entity has inherent benefits and negatives so choosing correctly is important. Here is a list of five different types of business entities.
The definition is in the name. A sole proprietorship is when there is one member of the business. These are great for anyone who is just starting. This means that the business requires no oversight from a board, executives, or shareholders. This gives complete control to one person. While this is a great advantage there exists an equal disadvantage to choosing a sole proprietorship. There will be no division between one’s finances and that of the businesses. From a legal perspective, the individual in charge takes on full legal responsibility for the business.
An LLC is one of the most common forms of business entities and for good reason. Unlike the sole proprietorship, an LLC does a great job of keeping the business separate from personal liability. In other words, the owner(s) maintain limited liability for the taxes and legal responsibility for the company. Choosing an LLC may be a good option for anyone doing business in real estate, profit sharing, or expecting startup losses. LLC’s provide similar freedoms like a sole proprietorship but with much lower risk.
A fictitious name is a business name that is used for doing business and may be completely different than the entity name. These are often referred to as “doing business as” or a DBA. What is a DBA? A DBA is the operating name of a company instead of the legal name of the company. Registering a DBA is typically easy to do, but there are a few clear disadvantages. For example, registering a DBA does not guarantee that the name used cannot be used by anyone else. In other words, another business could trademark the name and effectively stop one from using the name of a DBA all together. Using a DBA also does not protect the business owner from legal responsibility. Individuals who are looking for security in the business name and personal liability protection may want to stick with an LLC.
Filing for an incorporated business can be tricky. One such incorporated structures are called a C-Corporation (C-Corp) and it is a separate entity from the owner(s). This means that the entity is its taxpayer and therefore the responsibility does not fall to the owner(s). Choosing a C-Corporation is great for anyone expecting growth within the business, real estate, or profit-sharing. This helps to protect each member but also helps to keep the finances in the company. If someone was looking for startup capital from a venture capitalist a C-Corporation may be the best option. In other words, the responsibility for raising large startup capital does not taxably fall to the owner but the business itself.
An S-Corporation (S-Corp) is not registered as an individual taxpayer. Because of this, the liability for falls on each employee rather than the company. In other words, the profits lose, or taxes for the company are filed on one’s tax return. This option is great for any incorporated business who is looking to minimize the risk for IRS audits. Choosing an S-Corp could offer unique incentives for businesses like flexible accounting options. Depending on their type of business they can take advantage of the pass-through taxation structure. This means that they diminish the risk to the business and allow for greater control of salary and wages for each employee.
Choosing the right structure for a business is a big decision. While there may be overlapping pros and cons to both choosing correctly can be meaningful. Not only can it save time, but it can help set the tempo for growth.