Do you have a great idea for a business? Are you ready to be your own boss? If you are on the entrepreneur path, give serious consideration to the type of business entity that you create. Choosing correctly will help maximize your chances of financial and operational success.

There are multiple types of business entities and each has different nuances with regard to taxation, owner liability, and legal requirements.  A brief overview is below, but be sure to consult your business or tax advisor for more details.

Entity Types:

Sole Proprietorship

A sole proprietorship does not require the formation of a legal entity for state law purposes and assets do not have to be transferred to the “entity.”

  • Easy to form and operate
  • No state filing required to form
  • Business profit and loss reported on owner’s personal tax return
  • Owner remains personally liable for lawsuits filed against the business

Partnership

A partnership can either be deemed “general” or limited.”  In either case, a partnership consists of two or more partners who plan to carry out a business or investment activity for a profit. 

In a “General Partnership”, all partners are personally liable for the debts of the partnership with no limit.  Partners of a “Limited Partnership” have individual liability exposure only up to the amount that he/she personally contributed to the partnership. 

  • Easy to form and operate
  • Usually no requirement to form and file a partnership with the state
  • Each partner’s share of business profit and loss is reported on his/her personal tax return
  • Partners are personally liable for lawsuits filed against the business

Corporation

C-Corporation – Unlike the above entities, a C-Corporation is subject to federal income taxation on its profits. A corporate tax return must be filed and any tax due must be paid by the corporation. Earnings can be distributed to the owners (shareholders) as dividends. Each shareholder must report the dividends on his/her personal tax return. This means that income generated by the corporation is taxed at the corporate level and any income distributed is taxed again at the personal level. Shareholders are not personally liable for obligations of the corporation. 

S-Corporation – The S-Corporation allows profits of the corporation to flow through to the shareholders and be taxed at the personal level and not the corporate level. An entity must first file as a corporation and then make an IRS tax election to become an S-Corp. Limited liability protection for company directors, officers, shareholders, and employees is supported by this corporate structure.

C-Corp

  • Independent legal entity which provides for protection of personal assets from debts of the business
  • Profits are taxed at the corporate level and distributed profits (dividends) are taxed again at the personal level
  • No limitations on the number of shareholders
  • Annual meetings and recorded minutes are required

S-Corp

  • Independent legal entity which offers limited liability protection of personal assets from debts of the business
  • Profit and loss of the corporation is passed through to the shareholders and taxed on their individual personal tax returns
  • Limit on number of shareholders and shareholders must be US citizens or residents
  • Annual meetings and recorded minutes are required

Limited Liability Company (LLC)

The LLC has partnership and S-Corporation characteristics. The owners, which are referred to as members, of the LLC are not personally responsible for debts and claims of the business. However, they are not fully protected from other liabilities, such as direct injury to another, improper use of the LLC, intentional fraudulent, illegal, or reckless activity that causes harm to the business or another individual, and personal guarantee for company debt.

  • Independent legal entity which provides for protection of personal assets from debts of the business
  • Can be single member or multiple member
  • Governed by a formal operating agreement
  • Married individuals who are the sole members of the LLC are considered single member LLCs
  • A business tax return or tax form K-1 filing is not required for single member LLCs. However, it is required for multiple member LLCs
  • Business profit and loss reported on a member’s personal tax return based on his/her pro rata share of ownership
  • While you can change the structure of your business, doing so could expose you to tax consequences. Therefore, before you structure the legal side of your business consider the impact of taxation, personal liability exposure, and operational complexity.

Summary

Starting a business requires a lot of planning, important financial decisions, and legal undertakings. Choosing the appropriate legal structure for your business is key.  Working with an attorney, business consultant and perhaps the Small Business Administration (visit www.sba.gov for more information) can help to ensure a successful beginning.

This article was contributed by Kathy Hower, CFP, a Wealth Advisor at Bedel Financial Consulting, Inc.

Elaine E. Bedel, CFP, is CEO and president of Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. She is a featured guest each Wednesday on the WTHR (NBC, Indianapolis) Channel 13 News at Noon, “Your Money” segment.  Elaine’s book, “Advice You Never Asked For…But wished you had,” is available on Amazon.com. For more information, visit www.BedelFinancial.com or email Elaine at ebedel@bedelfinancial.com.

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