The business entity is a very important term from a business’s point of view. It provides various advantages for an established business. Usually, businesses form an entity to conduct their business activities. It is the type and structure of a business and it doesn’t indicate what a business does. Most of the businesses are owned by a business entity. So, if you have a business then does it own by a business entity?
The vast majority of businesses are owned by a business entity. It is like an organization created by an individual or individuals and it allows a business to engage in all kinds of trade or take part in similar activities. If you have an established business then it is surely owned by a business entity. If not then you have to form a business entity and there are various types of business entities are available. Therefore, you should analyze and choose the best type of business entity to make the most out of it.
What Is A Business Entity?
A business entity is a type of organization that is owned by one or more persons. Basically, business owners create business entities to conduct business, engage in trading, and participate in other business activities. Usually, the business entities are formed at the state level therefore, every business must comply with state laws. If you want to open a business entity then you have to submit documents with a particular state agency, like the office of the Secretary of State to legally set up the business. There are various types of business entities available and each business entity type decides the structure of a business and how it is taxed. So if you are a business owner or starting a new business then it is very important for you to pick the right business entity for your business. Because the decision you make about the business entity will have important legal and financial implications for your business.
How Business Entity Works?
Choosing the right business entity is one of the first steps new businesses should take. In fact, choosing a business entity could make or break your business. Because an entity decides what tax forms you should file and what happens if your business is sued. Many business entities protect your personal assets if your business is sued. If you want to form a business entity then you have to file paperwork with your state and have to pay the required fees. While picking a business entity you should consider the type of business and the number of owners. It is a very important decision from a business’s point of view, therefore; you should consult with tax and legal professionals for advice regarding your business.
Types Of Business Entities
There are quite a few types of business entities available which are recognized by states but most business owners choose from the below six types –
1. Sole Proprietorship
2. General Partnership
3. Limited Partnership
4. C Corporation
5. S Corporation
6. Limited Liability Company
1. Sole Proprietorship
This is the simplest business entity and it is considered as an unincorporated business with one owner or two owners (married couple). When you are the only owner of the business then the business automatically becomes a sole proprietorship by the rules. Therefore, a sole proprietorship is not a special business structure that needs to be registered to conduct business. So, you can become a sole proprietor automatically. Therefore, this business entity is mostly used by freelancers and other service professionals.
Pros Of Sole Proprietorship
1. This type of business entity is very easy to start
2. You will have the authority to protect the name of the entity
3. You don’t have to fill any documents to form this entity
4. There’s no limit to the number of people you can hire for your business
5. As the owner, you will have complete control over your business
6. The sole proprietorship is the first step to incorporation
7. Tax filing is also very easy for a sole proprietorship
Cons Of Sole Proprietorship
1. Personal liability is the main disadvantage of sole proprietorship and as an owner, you will be responsible for all of the business’s debts and liabilities
2. It is a bit difficult to apply for business loans if your business is a sole proprietorship
3. It is also very difficult to build business credit without a registered business entity
2. General Partnership
This business entity is quite similar to a general partnership but with some differences. The main difference is general partnership has two or more owners. Here, all the partners will be able to manage the business and share the profits. If there are multiple owners then it is the default business ownership. Like the sole proprietorship, you don’t have to register a general partnership with the state.
Pros Of General Partnership
1. This business entity is very easy to start because you don’t have to register your business with the state
2. There is no need to complete corporate formalities like meeting minutes, bylaws, etc.
3. This business entity faces simplified taxes because it doesn’t pay income tax
4. You can easily dissolve a general partnership whenever you want
5. You don’t have to share all the business losses because, in a general partnership, the partners divide the profits and losses
Cons Of General Partnership
1. This business entity lacks corporate structure, therefore; the business partners are unprotected from any lawsuits
2. Hare, business partners are liable for each other’s actions
3. Under this business entity, it is very difficult to get business loans
3. Limited Partnership
A limited partnership is a registered business entity, therefore; you have to fill forms to form a limited partnership. In most cases, you have to file paperwork with the state where your business is. In this type of business entity, at least one owner has to possess unlimited liability while the other partners are subject to limited liability, also known as limited partners. Usually, the limited partners are not actively involved in the management of the business. Therefore, they won’t lose more than the money that they have contributed to the partnership. So limited partners only act as investors and they also pay fewer taxes.
Pros Of Limited Partnership
1. Unlimited shareholders, so you can easily raise funds for your business
2. Investors and business owners will get certain tax advantages
3. Businesses will be able to use the financial/managerial strengths of partners
4. Businesses can have unlimited Cap on Capital Acquisition
5. There is liability protection available for limited partners in this business entity
Cons Of Limited Partnership
1. To form a limited partnership extensive documentation is required
2. Here, the general partners are responsible for the business’s debts and liabilities
3. Lack of legal distinction for general partners
4. The personal assets of general partners are unprotected under this business entity
5. It is also a bit difficult to collect loans for businesses from financial institutes
4. C Corporation
This is an independent business entity and it exists separately from the company’s owners. Usually, a C corporation is consists of Shareholders (usually the owners), a board of directors, and officers. Though, a single person can fulfill all of these positions in a C Corporation. So, if you are in charge of everything of your business then you can form a C Corporation. Usually, for a C corporation, the regulations and tax laws are a bit complicated compared to other business entities.
Pros Of C Corporation
1. C Corporation is a separate business entity
2. There are limited liabilities for the business owners
3. Business owners don’t have personal liability in C Corporation
4. In C Corporation, you have most chance to deduct tax compared to other types of entity
5. As a C Corporation owner, you can pay lower self-employment taxes
Cons Of C Corporation
1. It is more expensive to form a C corporation compared to other business entities
2. C corporations face double taxation where the business has to pay taxes on the corporate tax return and the shareholders have to pay taxes on personal tax returns
3. It is much more complex to operate a C corporation
4. You have to fulfill various formalities like organizing shareholder meetings, etc.
5. S Corporation
S corporation is a type of business entity that meets specific Internal Revenue Code requirements and also preserves the limited liability that comes with a C corporation. In this business entity, the profit and loss of the business pass through to the owners’ personal tax returns.
Pros of S Corporation
1. This business entity protects the personal assets of its shareholders
2. There is no corporate taxation and double taxation in this business entity
3. You can easily transfer the ownership of an S corporation
4. You will have the option to write off start-up losses
Cons Of S Corporation
1. S corporation is very expensive to form compared to other business entities
2. There are many limitations on issuing stock with S corporation
3. Like the C Corporation, you have to fulfill various formalities in an S corporation
6. Limited Liability Company
A Limited Liability Company shortly known as LLC is a very popular business structure where the owners are not personally liable for the company’s debts or liabilities. Basically, LLC is a hybrid type of entity that includes all the positive features of other business entities. Another advantage of an LLC is, you can choose how you want the IRS to tax your LLC.
Pros Of Limited Liability Company
1. There are no business debts or liabilities for the business owners
2. You have the opportunity to choose the LLC to be taxed as a partnership or as a corporation
3. LLC ensures management flexibility for the business
4. Compared to S and C Corporation, the paperwork and fees are less for LLC
Cons Of Limited Liability Company
Compared to a sole proprietorship or partnership, it is a bit expensive to form an LLC
How To Choose The Best Business Entity Type
If you want to find out which is the best business entity type for your business then you must have a clear understanding of these entity types. The above information will help you develop a clear idea about the business entities but if you can afford then you should consult a business lawyer and tax professional and see that what they say about your business and the right business entity. Though, there are three general factors available that you must consider when choosing a business entity from the available options. Below is the summary of these three factors for different business entities –
Sole Proprietorship
1. Limited Liability Protection: No.
2. Tax Treatment: Taxed at a personal tax rate
3. Level of Government Requirements: Low
General Partnership
1. Limited Liability Protection: No
2. Tax Treatment: Taxed at a personal tax rate
3. Level of Government Requirements: Low
Limited Partnership
1. Limited Liability Protection: For limited partners only
2. Tax Treatment: Taxed at a personal tax rate
3. Level of Government Requirements: Medium
S Corporation
1. Limited Liability Protection: Yes
2. Tax Treatment: Taxed at a personal tax rate
3. Level of Government Requirements: High
C Corporation
1. Limited Liability Protection: Yes.
2. Tax Treatment: Must pay corporate taxes
3. Level of Government Requirements: High
Limited Liability Company
1. Limited Liability Protection: Yes
2. Tax Treatment: Can choose how you want to be taxed
3. Level of Government Requirements: Medium
Final Thoughts
Finally, the entity you choose for your business directly affects the outcome of the business. Moreover, it also plays a very important role in legal exposure and finances. Therefore, study and research well and consult with the professionals before determining the business entity type for your business.
References:
1. https://www.thebalance.com/business-entities-3193420
2. https://www.asha.org/practice/businessentities/
Last Updated on February 6, 2022 by
Magalie D. is a Diploma holder in Public Administration & Management from McGill University of Canada. She shares management tips here in MGTBlog when she has nothing to do and gets some free time after working in a multinational company at Toronto.
