To set up a new business, the owner will need to select the correct type of business entity. This entity type can later decide the personal liability, tax treatments and benefits and whether business interest can be sold. As a new business owner, you should take care when making this decision.
Here are a few things to note about each type of business entity:
A sole proprietorship is usually not registered with the state and by definition, is owned by an individual. This can be a simple setup that requires no registration. However, with a sole proprietorship, you, as the owner, receive no liability protection. That means in case of business debt or lawsuits, your personal assets will be at risk. Also, note that for certain types of businesses, you are required to obtain a license or registration, even as a sole proprietorship. Be sure to understand applicable industry law and local regulations in regards to business entity options to avoid unwanted surprises.
Partnerships may need to be registered with the state. They also are required to report returns, losses, and deductions to the IRS every year. Partners often will enter an agreement to determine how profits, expenses, and workload should be divided among themselves. A good agreement among partners will lower the risk of disputes and conflicts down the road, which can be costly to a young business. However, keep in mind that as a partner, you may be exposed to a greater liability. Like a sole proprietorship, the owner receives no liability protection. Additionally, each partner is also responsible for certain actions of the other partner(s).
C-corporations, or corporations, can be owned by one shareholder or more. Initial capitals can be raised by contributions from the shareholder or by selling stocks. With a corporation, the owners are protected from legal liability. Their personal assets are protected in case of debts and lawsuits. However, setting up a corporation may require a lot of time and paperwork. You will also need to keep clear records and ensure that the business stays in compliance. In certain cases, corporation income can be taxed twice, both as profit to the corporation and then as dividends paid to shareholders. This is why expert opinions are often recommended when it comes to corporate taxes.
S-corporations are corporations except with an S-corp election made with the IRS. This status avoids the double taxation. Unlike the C-corporations, shareholders of S-corporations are taxed personally. To become an S-corporation, there are certain requirements. For example, the corporation cannot be a foreign one. It cannot have more than 100 shareholders or more than one class of stock. The shareholders cannot be non-resident aliens, corporations, partnerships or certain types of trusts and estates. Certain businesses are also excluded, including insurance firms, certain financial institutions, and domestic sales corporations working internationally.
Limited Liability Companies (LLC)
With an LLC, the members can have similar liability protection. Your personal assets cannot be claimed by the LLC’s creditors. However, the liability protection is limited. Members are not protected from illegal and wrongful acts, even if these acts are committed by an employee. With the LLC business entity, there is less record keeping required than with a corporation. Distributions of profits are less restricted, and members of the LLC can decide how to distribute profit.
To help determine the right business entity type for your startup, talk to a legal expert. Contact a LegalShield consultant today to learn how you can get legal advises, services, and protection for less than $1 a day!