You're Starting a Business: How Do You Choose the Right Entity Type?

Deciding on the best entity type to set up for your business can be challenging. With so many options and so much unclear information, how do you even choose?

Well, worry no longer. In this article, we'll go through each business structure. This'll help make your choices as small business owners that much simpler. 

When to start a sole proprietorship

The first on our list of business structures is the sole proprietorship.

A sole proprietorship is the appropriate choice when you're the sole owner. This type of business structure is also unincorporated. This means it's not a separate legal entity, and the business assets are not independent.

Of course, this also means that there are some disadvantages; the business owner is liable for:

1. all debts related to the business.
2. taxes accrued by the business.

The owner's personal income and assets will be at risk if the business goes into debt. Owners also have to pay self-employment taxes.

As advantages, however, sole proprietorships are (1) easy to set up and (2) cost-effective.

Typically you'd find that freelancers and contractors will operate as sole proprietors.

When to join a partnership

Second, on our list of business entities are partnerships.

The partners assume personal liability for all debts related to the business. That is unless a limited partnership (LP) is agreed upon.

In this case, the general partner is involved in the day-to-day running of the business. And the limited business partner has limited liability up to their investment amount.

The main disadvantage of this business structure is that it ends upon a partner's death. And should another partner wish to join, another agreement has to be drawn up.

General partners must pay, like a sole proprietor, self-employment tax.

However, like sole proprietorships, partnership agreements are easy to form. The transfer of ownership is also relatively simple.

When to set up a limited liability company (LLC)

Limited liability companies are the “halfway choice” business legal structure.

Like Corporations, in an LLC, members have limited liability protection. This means that they're not liable for the debts and taxes of the business entity. Business and personal assets are separate.

Small business owners can form limited liability companies with just one person. However, they can comprise more.

Profits and losses pass to members, who report these on their individual tax returns. Because of this an LLC is known as a pass-through entity.

LLCs are separate legal entities utterly distinct from their owners. Like individuals, they can enter into contracts, pay taxes, and hire people.

Opt for an LLC if you want the tax benefits of avoiding double taxation. This is when the owner and the company are taxed on earnings.

When to register a corporation

Corporations are separate legal entities, like LLCs. Shareholders aren’t personally liable for their debts. One person can start a corporation. Although they typically comprise more than a single individual.

Take note: Corporations may be too complicated to start for some small businesses.

Corporations boast limited liability, although they vary in the method of taxation. As a result, there are two main types of corporations:

S corporation

S corporations get their name from Subchapter S of the Internal Revenue Code.

All business income and losses pass directly to the shareholders for tax purposes. This avoids the issue of double taxation, like limited liability companies.

C corporation

C corporations also get their name from the Internal Revenue Service Code. However, they get their name from Subchapter C.

In this type of corporation, all income and losses are the corporation's responsibility. C Corporations are also subject to corporate taxes.

Take your time

Deciding on the right business structure is not a decision you want to rush into: take your time. Deliberate on your needs and future aspirations. It's a big choice to make.