Business Entities 101
When I met with a potential client for the first time, one of the first questions I get is, “What type of business should I be?” With the wealth of information you can find online, the choice can sometimes seem overwhelming. While you have several options I’ve written this article to give you an overview of the what they are. I’ll be posting follow-up articles to help you make the best decision for your business.
The most common business type we see on TV is the C-Corporation or C-Corp. These are your Uber’s, Facebook’s, and Coca-Cola’s of the world. Their owners own stock in the business and it can be held by one person or tens of thousands. They pay their own taxes and the business owners also pay tax. This is sometimes called double taxation. This is the go-to option for those looking to have an IPO in the future.
Next we have S-Corps - sometimes referred to as small business corporations. They also have shareholders, but are limited to only 100 shareholders. The nice thing about S-Corps is that the shareholders pay the tax on their personal return by reporting the K-1 income (allocated based on ownership percentage) they receive and the business doesn’t have to pay tax at the entity level. Therefore, they avoid the double taxation issue of C-Corps.
LLCs - I call them hybrids - are the most common business entity I see solo-preneurs opt for. They’re easy to set up and if done correctly, you avoid the personal liability that can be a problem when you are a sole-proprietor. The reason I call these hybrids is because of the flexibility you have to pick your tax treatment. If you’re a solo-preneur you can either have your business come through as Schedule C income OR you can file a form to have it taxed as a corporation. If your business is more than just you, you all are referred to as members. As members of the LLC, you have more options. You can be taxed as a partnership (see the partnership section for more guidance), taxed as a C-Corp, or you can make an election to be treated as an S-Corp and taxed in that manner. The reasons why someone may make one choice over another is dependent on their goals. You should talk to a CPA to help you make the right decision.
Finally, we have partnerships (LP & LLPs). You will see a lot of professional services organizations use LLPs and many investment vehicles use LPs. To function properly, they must have a partnership agreement. This agreement will highlight how the organization is managed, the ratio of profit sharing, and dissolution of the partnership. Partners in an LLP are also legally liable for their own negligence. These entities allocate income and losses based on a share of ownership similar to S-Corps, but operate slightly differently based on the tax code. The majority of small business owners do not need to use this entity structure.
If you’re interested in getting into the nitty-gritty, check out this resource from the IRS here.
If this made sense to you, leave a comment below! As always, you can feel free to leave questions below as well.