When forming your own business, one of the first questions that needs to be answered is: what kind of business entity should I be? There are several options – Sole Proprietorship, Partnership, Corporation (C-Corp), S Corporation (S-Corp), or Limited Liability Company (LLC) – and at Ulrich & Associates, our goal is to help you decide what the best option will be. Here is a brief overview of these five entity types, including some of their advantages and disadvantages.
A Sole Proprietorship is a company run by one person – you. You hold all the decisions of running the business. It is easy to form and simple to operate. The entity is not taxed separately; rather all income and losses pass through to your personal taxes. The major drawback here is that the owner (you) is personally liable for all obligations of the business.
Advantages – easy to form and operate; fewer administrative burdens; all taxation is at the owner level, not the business level.
Disadvantages – raising capital can be difficult; you are personally liable for all obligations of the business; there is no continuation of the business past you; all net income of the business is subject to self-employment (SE) tax.
A Partnership is a company run by two or more people, called partners. These partners agree, generally through a document called a partnership agreement, on the way that operations, profit, and loss are divided amongst the partners. Like a sole proprietorship, income and loss from the business pass through to the partners, although they remain personally liable for all obligations of the business.
Advantages – more sources of capital and more management resources; pass–through taxation.
Disadvantages – transfer of interest is difficult; partners are personally liable for the business; partnership tax rules are generally more complex than other entities.
A Corporation (or C-Corp) is a legal entity, separate from its owners, created to conduct business. Unlike other entities, owners are not personally liable for the obligations of the business. The main disadvantage is that all earnings of the company are subject to taxation at the corporate level, and then taxed again at the personal level on earnings distributed as dividends to shareholders.
Advantages – owners have limited liability; corporations have perpetual life spans; capital is easily raised and transferred through the use of stock.
Disadvantages – earnings may be subject to tax on the corporate and personal levels; corporations are relatively more difficult to form and dissolve; administration becomes increasingly burdensome.
An S Corporation (or S-Corp) is a variation of a C-Corp which is generally advantageous to smaller entities. Like a C-Corp, the owners have limited liability on the obligations of the business. However, the entity remains “pass-through,” meaning the earnings of the S-Corp are not subject to corporate tax.
Advantages – owners have limited liability; it is a pass-through entity, so it is not subject to corporate tax.
Disadvantages – number of shareholders limited to 100 – no corporations, partnerships, or nonresident aliens are allowed as shareholders; there are restrictions on the choice of tax year.
A Limited Liability Company (or LLC) is a hybrid entity which combines many of the advantages of partnerships and corporations.
Advantages – all members have limited liability; no limit on the number of members; may elect to be taxed under partnership, S-Corp, or C-Corp rules; members may participate in management.
Disadvantages – LLC laws vary from state to state; transferability of interests may be limited; entity may have a limited life and the tax year choice may be restricted.
With this quick overview, hopefully you have a better understanding of the options available to you. Of course, one size doesn’t fit all, so let the experts at Ulrich & Associates work with you to determine the best course of action. After all, your livelihood is at stake!