Back to the Basics: Understanding the Various Kinds of Business Entities

If you’re starting a new business, there many things you have to worry about—from getting funded to figuring out who to work with. But before you get started, the first thing you will need to do is choose the kind of business entity that is right for you. There are several options, which can make this process overwhelming. Each has its own advantages over the other, so in order to make sure you select the right entity for your business, review our list below to learn about the most common types.

C-Corporation

C-Corporations (C-Corps) are ideal for those who are looking for the least restrictions in terms of growth. They provide the most flexibility when it comes to raising funds and you can issue an unlimited amount of shares to an unlimited number of investors. But, unlike other entities, C-Corps have double-taxation.This may be unattractive, especially for those looking to keep their businesses on the smaller side, because it means that there are separate legal and tax structures so you are taxed twice on the same income.  

S-Corporation

One of the main differences between S-Corporations (S-Corp), or Small Business Corporations, and C-Corps are that they have different tax structures. S-Corps have “flow through taxation.” This means that profits flow through the entity straight to its owners. It follows that the owners are taxed and the entity is not, meaning the S-Corp avoids double-taxation. Another difference is that S-Corps are more restricted in who and how many people they can issue stock to raise capital. For instance, you can only have up to 100 shareholders and they all must be US citizens or permanent residents.

Limited Liability Company

The Limited Liability Company (LLC) is probably the most flexible and favored of all the entities. With an LLC, the members and owners are shielded from any personal liability if anything goes wrong. Further, every investor is only liable for the total amount they invested. This means that you cannot be held liable for anything over what you have personally put into the company. LLCs are also very flexible and do not require members to give up their limited liability in order to have a hand in the day-to-day operations of the company like other entities do. Lastly, like an S-Corp, the LLC avoids double taxation.

General Partnership

General Partnerships (GPs) have a more simple structure than corporations. There are no fees or forms associated with forming a basic partnership. Further, owners all share equally in profits and losses. They may report losses on personal income taxes but they have to pay personal income taxes on any profits the GP makes. However, a disadvantage is that all partners are jointly and severally liable for any debts or liabilities on the GP itself. This means that you can be held accountable for something your partner did that you had no hand in.

Limited Partnership

In a Limited Partnership (LP), there are both general and limited partners. One of the biggest advantages is that the limited partners only face limited liability. This means that if the business is sued or goes bankrupt, then limited partner is only liable up to his investment in the business and the business’s assets. In contrast, the general partners remain jointly and severally liable just like in a GP. Because, the LP affords additional protections to more of its members, it can be an attractive option for small business owners.

Sole Proprietor

A sole proprietorship (SP) is the simplest structure. In an SP, the owner and business are legally the same entity, making this very easy to form and maintain. As the owner, you would be responsible for all transactions and liability that result from your business’ actions. Further, because all profits and losses are accounted for on the owner’s personal tax returns, there are no additional corporate tax payments. Because of its simplicity, the SP may be the right choice for you if you plan to run your business alone.

Business Trust

The Business Trust is an entity that is only in Virginia and a few other states, but can be very useful for those who own a number of pieces of real estate.  The Business Trust can have series beneath it that are distinct from each other by law.  Using a Business Trust, you can create a series for each different real estate holding you have, but file a single tax return at the Business Trust level to cover all economic activity of the various series and the holdings of each series are distinct from each other for liability purposes. Business Trusts vary a good deal among the states where they exist, so one needs to be very careful in setting one up.

Tax Status

S-Corporation is actually a tax status that is available to any kind of entity.  This means that you can form a limited liability company, for example, and elect to be treated as an S-Corporation for tax purposes.  The status does not alter anything else with the entity and you must still meet the number and kinds of equity owner restrictions for S-Corporation status, but it can provide the owners with some tax savings, particularly the lack of self-employment tax on profits.

Qualifications

Once your entity is formed, you may find that there are various qualifications that you may apply for that can help you with your business.  If you are a veteran or a service-disabled veteran, you may be able to get qualified as a Veteran-Owned or Service Disabled Veteran-Owned business that will give you advantages when trying to get federal government contracts.  Federal 8(a) Certification is a federal qualification for small disadvantaged businesses that can help also with federal contracting.  Individual states have qualifications programs for small, minority or woman-owned owned businesses.  Each of these statuses has special requirements that your entity must meet and if you are considering applying for one of them, you will need to be set up correctly from the start.  

Before starting the process of actually forming one of these entities, it’s important to speak with an experienced business law attorney so that you can make sure you choose the right structure for your business. Not only is choosing the type of entity a big decision, but many states also impose their own set of requirements on business owners prior to, during, and after incorporation. Further, if you are a veteran, you may be able to get certified as a Veteran-Owned Business.

At the Wilson Law Group, we frequently help our clients, many of whom are veterans, start their own businesses and are prepared to help you select the entity that is right for you. If you are looking to form your own company, don’t hesitate to contact the Wilson Law Group today!

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Wilson Law Group

Jim Wilson is the founder and principal attorney of the Wilson Law Group. For the past 25 years he has been combining legal dexterity with an entrepreneurial mindset to help aspiring and established business owners start, finance, buy, sell, and run their companies.

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