When you're starting a business, one of the first considerations you'll have to make is what type of business entity you'll use. A business entity is an organization created by one or more people to conduct certain business activities or engage in a trade.

It's important you determine your business entity for tax considerations and future business expansion plans. When starting your business, there are 4 types of enterprises you can choose from, each with its legal structure and standards. This article will provide you with a quick summary of the 4 types, to help inform your decisions.

THE 4 TYPES OF BUSINESS ENTITIES

1. Sole Proprietorship

This is a business that is conducted only for the benefit of one person. It is the most basic type of business structure. Apart from the owners, proprietorships do not exist. The business's liabilities are the owner's personal liabilities, and the business ceases to exist when the proprietor dies. The proprietor assumes the risks of the business to the extent that his or her assets, whether used in the firm or individually owned, are sufficient to cover such risks.

Professionals, service providers, and shopkeepers who are in business for themselves are examples of single proprietors. Although a sole proprietorship is not legally distinct from its owner, it is treated as such for accounting purposes. The business's financial activities (such as fee receipts) are kept separate from the individual's personal finances.

2. Partnerships

It is a collaboration between two or more people (people, corporations, other partnerships, LLCs, trusts, or others) to run a business for profit as co-owners. These people are in charge of the company, including its liabilities and profits or losses.

The people who are planning to form a partnership, agree to share earnings and losses. The partnership must file an informative return with the government, detailing the partnership's income and losses, as well as how they were distributed to the partners. Because partners' liability is joint, any one of them can be forced to pay the partnership's whole debts, regardless of how profits and losses are distributed or whether capital contributions are made. It's critical to establish a partnership agreement that spells out what happens if the partners disagree and one wants to leave the partnership or dies.

General partnerships, limited partnerships, and limited liability partnerships are the three forms of partnerships.

General Partnerships: This is the simplest sort of partnership to organize and maintain, with minimal ongoing expenses. Every partner is deemed to be a participant in the business's operations, and each one bears limitless liability. This means that each partner's personal assets can be used to pay down the partnership's liabilities. This also implies that each partner is accountable for the conduct of the others.

Limited Partnerships: There is at least one general partner in this sort of partnership. This general partner assumes unlimited liability for the partnership and is in charge of the company's operations. There are also limited partners liable only for the amount of their financial investment in the company. They are not involved in management decisions and have no direct influence over the business.

Limited Liability Partnerships (LLPs): are similar to general partnerships in that numerous partners share responsibility for the business's operations. However, LLP partners are not personally liable for the actions of other partners or the business's debts. Unfortunately, not all firms are eligible to form an LLP. Certain professionals, such as lawyers and accountants, are often barred from engaging in this type of business.

3. Corporations

Corporations are regarded as legal persons and are considered separate entities for tax reasons. This means, among other things, that a corporation's profits are taxed as the "personal income" of the corporation. The income delivered to shareholders as dividends or profits is then taxed as the owners' personal income.

The company's owners (called shareholders), board of directors, and officers are in charge of making decisions. It is feasible for a single individual to fill all of those duties, and there are businesses with only one owner that are registered as corporations. The criteria for forming and sustaining a corporation vary by state, but it is often a more formal process than forming and maintaining other forms of business entities.

C-Corporations and S-Corporations are the two forms of corporations. The tax status of the two entities is the most significant difference between these two.

C-Corp: A C-Corp is treated as a separate taxpaying entity for federal income tax purposes, and it files its tax return (Form 1120). Any profits earned by a c-corporation are subject to corporate income tax (entity pays taxes). The business gains transferred to the owners are taxed at a personal level by the shareholders. As a result, C-corporations face "double taxation."

S-corp: For federal tax purposes, S-Corps elect to pass through company income, losses, deductions, and credits to their shareholders. The entity must, however, record income, losses, gains, deductions, credits, and other items on Form 1120S. S-corp shareholders report the corporation's profits and losses on their tax returns and pay federal income tax at their rates. As a result, S-Corporations avoid double taxation.

4. Limited Liability Company (LLC)

You can benefit from the advantages of both the corporation and partnership company forms by forming an LLC. It's a type of business structure that shields owners from personal liability for the company's debts and other obligations. Profits and losses can also be transferred to your personal account without incurring corporation taxes. Members of an LLC are deemed self-employed and must contribute self-employment taxes to Medicare and Social Security though.

If the business doesn't perform as expected or you have a bad year, an LLC protects you as the business owner personally. So your car, house, and savings accounts are protected if your LLC is sued or goes bankrupt.

LLCs are an excellent choice for medium- to high-risk businesses, owners with significant personal assets, and owners who wish to pay a lower tax rate than they would if they ran their firm as a corporation.

BOTTOM LINE

Choosing the correct business entity for your small business is a crucial decision, and while there are a million things to do when you're just getting started, this isn't one to overlook. Your choice of business structure will influence your day-to-day operations, as well as legal, tax, and liability concerns. So, think about the type of business that will work best for you.