Business Entities Breakdown

Blog post 1 of 2. This post will dive into the differences (from a tax perspective) of five different entity types. The follow up post will go into more detail aboust recordkeeping, expenses, and other finances associated with each entity.

In business, there exists five main types of entities: Sole Proprietorships, Partnerships, C-Corporations, S-Corporations, and the LLC.

Sole Proprietorships:

A sole proprietorship is a business of one without corporation or limited liability status. The pros of a sole proprietorship is that there are no formation costs, no yearly fees, full control to the owner, and minimal recordkeeping requirements.

The cons, however, are the self-employment tax which is 15.3% of income. Additionally there is no liability protection, can only involve one person, there are limited tax benefits, and any losses seem to generate IRS scrutiny.

Partnerships:

A partnership is a type of business entity in which partners (owners) share with each other the profits or losses of the business. The pros of a partnership is that it is very easy to setup, it can involve unlimited partners, it is extremely flexible (in terms of ownership percentage, general vs. limited partners, and asset protection), there is no need for payroll, and there is less record keeping htan corporations.

The cons, however, are the self-employment which, like the sole proprietorship, is 15.3% of income. There are also potential state fees and limited tax benefits.

C-Corporations

A C-Corporation is a legal form of business entity that may have an unlimited number of shareholders. The pros of this includes no self-employment tax and tax deductible benefits (i.e. reimburesement plans and medical). Additionally, this offers the strongest asset protection.

The conts, however, include the setup process that is required (a lot more of a hassle than your partenerships or sole proprietorships) as well as state fees, double taxation, the recordkeeping requirement, and the salary requirement.

S-Corporations

An S Corporation (Small Business Corporation) is a business elected for S Corporation Status through the IRS. This status allows the taxation of the company to be similar to a partnership or sole proprietor as opposed to paying taxes based on a corporate tax structure. The pros of an s-corporation include the associated strong asset protection along with the no self-employment tax and lower payroll taxes. S-Corporations also have some tax deductible benefits.

The cons, however, include the setup process, state feeds, recordkeeping requirements, and the salary requirements.

The LLC (Limited Liability Company)

A limited liability company in the law of the vast majority of United States jurisdictions is a legal form of business company provides limited liability to its owners. This is the most versatile entity and can be taxed as any of the four.

This is essentially "an insurance policy" that is sold by the state. An LLC offers liability protection in registered states. Yearly fees and filing requirements do vary by state.


Entity Setup Steps

Your entity first needs to be formated with the state. Incorporation/organizational papers need to be filed with the Secretary of State. The entity also needs to be registered with the IRS. With the process, a Federal ID Number is obtained. To become an S-Corp, you will need Form 2553 and to establish taxation type for an LLC you need Form 8832. It is also essential to establish a business plan in relation to your entity.


Establishing a Bank Account

Requirements to open an account vary by bank. However, there are a few guidelines that most, if not all banks, utilize for a business to open a bank account. These include having a Federal ID Number, Articles of Incorporation/Organization, and a state business license. All entitles should have their own bank account. This is not required, however, for sole proprietorships.

Business Plans

When creating your business plan, your mindset should be "What is my business going to do and how will it go about it?" This includes creating a msision statement, establishing organization & management, and all financials. Clearly outline your benefits as well. Include your competitive advantage as well as your goals and projections. This will make it easier to obtain a business and will help you track your business progress. Keep in mind that this is not set in stone as it is to be expected that you will change some aspects of your business.


The next blog plost will discuss business loans & financing, recordkeeping requirements, basic tax filing requirements, deductions, and various expenses