Entity Types
Starting a business requires choosing what type of Entity you wish to run your business under. There are only a very few choices, but many variations on each type. Based on your expectations for your business you should choose from the main choices of sole proprietorship, Partnership, Limited Liability Company (LLC), Corporation or Nonprofit. Of course, there are variations that may come into play. For example, as a corporation you may choose to be a C corporation, S corporation, or a Nonprofit corporation.
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Lets look at the main entity types
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Sole Proprietor – If your business will be all about You, and you expect to run your business entirely on your own then you will probably become a sole proprietor. There is also the advantage of having full control. Many tradespeople such as plumbers and carpenters are sole proprietors. A sole proprietor files a Schedule ‘C’ with their personal tax return.
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Partnership – Two or more people who oversee business operations and share profits, losses and liabilities. Agreements among the partners may vary. All partners share profits and losses according to the partnership agreements. Partnerships are ‘pass through’ entities, meaning that the partnership is not a taxable entity, but passes all income and losses through to the individual partners. Client based Professionals are usually found in partnerships. Doctors, lawyers, accountants, architects, etc. Partnerships file form 1065 and distribute form K-1 to the partners who then include the K-1 information on their personal tax returns.
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LLC (Limited Liability Company) – Is a business structure that protects its owners from personal responsibility from debts or liabilities. In similar fashion to the Partnership the LLC is a ‘pass through’ entity as well. LLCs are State regulated and therefore specifics may differ from one state to another. The LLC is somewhat of a cross between a Partnership and a Corporation. In a Corporation ‘Shareholders’ are the owners whereas in the LLC owners are referred to as ‘Members’. Members of an LLC usually take a more active role in running the business whereas many Shareholders normally are not involved with operations. The LLC relieves the ‘double taxation’ stigma that the Corporation has and may be a better choice for small business or for those with intent of having only One member (owner). Possible disadvantages to an LLC is the cost of formation which is about the same as incorporation, and the treatment of Members leaving the LLC which requires specific actions and realignment. The LLC files a Partnership Return (Form 1065) or elects to file form 8832 to be treated as a Corporation and then files form 1120. K-1 forms are issued to the members who file the K-1 with their personal returns.
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Corporation – Corporations are best suited to larger organizations and those that may use ‘investors’ who would share ownership as stockholders. Corporations are business entities that are separate from their owners. Corporate tax structure is such that profits may be ‘double taxed’. When profit is earned the Corporation is taxed on those earnings, then when the earnings are distributed, the individual shareholder is again taxed on the money earned. Corporations are regulated by the State and may differ from state to state. Corporations have the option of choosing to be an ‘S’ corporation. The ‘S’ corporation follows the pass through method for Income and expenses and is usually used for smaller organizations. Corporations file tax form 1120 or 1120S.
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Nonprofit – Under Section 501 of the Tax code we find a number of special entities that fall into Nonprofit, charitable organizations and small Tax-exempt entities. The true Nonprofit organization would structure as a 501 (c) (3) entity seen as a Nonprofit Corporation. As a designated nonprofit or tax exempt organization you would file some form of the 990 tax return.
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