Starting a business is a long and complicated process, especially for a new entrepreneur. One of the first decisions you will need to make is what type of business structure you want to form.
The most common types of business structures that entrepreneurs choose for starting a business are:
- Sole proprietorships
- Limited Liability Company (LLC)
All of them have their own advantages and disadvantages. Before choosing the right type of entity, make sure you understand the implications of your choice for your business.
Starting a business: what factors should you consider when choosing a legal entity?
Your choice will guide the way you operate your business for years to come. That’s why it’s a decision you need to make after careful research and planning.
When considering different types of entities for starting a business, here are some of the factors to consider:
- Ease of training
- Tax implications
- Terms of ownership
- Liability protection
- Administrative expenses
Whatever type of entity you choose, you can use a platform like GovDocFiling to register your business quickly.
When using the platform, you only have to complete one application for state and federal business start-up filings. The expedited processing system guarantees you a hassle-free experience.
Starting a business: what you need to know about the different types of entities
Before you formally begin any business creation process, you need to understand what each type of entity has to offer. You can then compare them on the settings we discussed in the previous section.
In this section, let’s discuss the most popular entity types in detail.
1. Sole proprietorship
A sole proprietorship is the simplest business structure in terms of the paperwork of starting a business. Other than your EIN (Employer Identification Number) or tax identification number, the state does not require any additional training process.
However, if you choose to run your business under a fictitious name, you will also need to file for Doing Business As (DBA).
Sole proprietorships can only have one individual as an owner and follow a pass-through tax system.
Sole proprietors will be required to report all of their business’s profits and losses on their personal tax returns. They must also pay a separate self-employment tax to the federal government.
In the event of a lawsuit, full financial responsibility rests with the owner and his personal property may be seized if he does not pay his debts.
2. Limited liability company (LLC)
Startups and small businesses often choose to form a limited liability company because it limits their liability and protects their personal assets.
To form an LLC, you will need to file a document called the Articles of Association. For this business creation procedure, you will have to pay an application fee. The exact fees vary by state in the United States.
The tax structure of LLCs varies depending on the number of members of the LLC.
Single-member LLCs are taxed like sole proprietorships, while multi-member LLCs are taxed like partnerships. However, members can also choose to tax their LLC as a corporation.
A partnership is a legal entity in which two or more owners contribute their money, time, property or labor before sharing the profits and losses of their business.
For starting a business, there is only one requirement for partnerships – you must obtain your Employer Identification Number (EIN).
Partnerships are easy to maintain because partners do not need to file both corporate and personal income taxes. They only have to report the profits and losses of their business as individuals. This system guarantees the absence of double taxation.
A company is a corporate structure formed by an individual or a group of individuals with a charter.
Once the business creation process is completed, a company has certain rights, powers, responsibilities and privileges. These companies are also known as C-corps.
The legal formality can be completed at the Secretary of State. Once incorporated, a company has an indefinite life and becomes its own legal entity.
The corporate tax system is relatively complex. The Company itself is taxed and the distribution of profits that is given to shareholders is also taxed on individual shareholders’ tax returns.
However, owners can choose to pay themselves a year-end bonus or a salary to avoid the double taxation scheme.
5. Company S
An S-Corporation is a good option for anyone who wants to start a company but wants to avoid double taxation. There are certain requirements for forming an S-Corporation, including having less than 100 shareholders.
S-Corporations follow a pass-through tax system, similar to partnerships, LLCs, and sole proprietorships.
All federal tax on the profits and losses of an S-Corporation is passed on to the shareholders’ individual tax returns. This is one of the main differences between an S corporation and a general corporation.
The S-Corporations tax system has a main advantage over partnerships and sole proprietorships. They do not have to pay self-employment tax on their share of the profits.
However, there are also additional tax requirements for S corporations. These vary by state in the United States.
Ready to make a choice?
Choosing the right legal entity is one of the most important decisions when it comes to starting a business. It will set the tone for how you will run your business in the future. Use the information above to compare the pros and cons of different types of entities.
Take into consideration the operational needs, ownership requirements, and tax process of the business while making your decision.
Use this article as a guide to starting a business on how to choose the right business structure. All the best for your business creation process.
Brett Shapiro is co-owner of GovDocFiling. He had a entrepreneurial spirit from an early age. He launched GovDocFiling, a simple resource center that takes care of mundane, but critical, training documentation for any new business entity.
Interesting related article: “S-Corporation vs LLC, which one is better for your startup?” “