What type of business entity is best for me? This is a question every entrepreneur asks, and finding the right answer will have a huge impact on your business.
The most popular business entities
I’m Neil Fridman, managing partner of the Fridman Law Firm PLLC. Today, I want to break down a few of the most popular business entities available to entrepreneurs and small business owners to help you understand which one might be the best fit for you.
The reason this is so important is that the legal structure of your business will have a direct impact on two very important areas. The first area is how much your business pays in taxes each year, and the second is whether or not your personal assets are exposed to the business, should it incur debt or possibly fail.
Sole proprietorships and partnerships
Let’s start with the most common business structures, which are sole proprietorships and partnerships. Sole proprietorships and partnerships are the easiest and cheapest entities to establish. Both are considered pass-through entities by the IRS, which means all profits and losses will pass through the business and be filed on your personal tax returns.
Despite how easy they are to establish, we typically advise our clients against choosing sole proprietorships or partnerships. The reason for this is because as an owner, your personal assets will be exposed to any business debts and potential lawsuits.
What we recommend
The primary business structures we steer our clients towards are C and S corporations as well as LLCs and LLPs, depending on the circumstances. Each of these entities provides a liability shield for the owners, but they differ in how the business is taxed.
C and S corporations
First let’s discuss C and S corporations, which are both named after sections of the internal revenue code. Like sole proprietorships and partnerships, S corporations are also passive entities and are generally better for small businesses. On the other hand, taxes for C corporations are paid first at the corporate level, and any dividends distributed to owners are also subject to tax. This is called double taxation.
If you have any dreams of taking your company public or taking on venture capital money, a C corporation is a very good entity for you. Forming a corporation makes it easier to raise money from investors. The downside is that it’s more expensive to form and will be subject to more rules and regulations. It will also require more stringent record keeping.
LLC and LLP
If you’re looking for lower start-up costs and more flexibility in your business, an LLC or limited liability company or an LLP or limited liability partnership might be a better option for you. Both the LLC and LLP have increased in popularity over the last few years due their hybrid structures that offer tax and flexibility benefits while also limiting personal liability.
An LLC can have a single member or multiple members and offer more tax flexibility as it can opt to be taxed as a pass-through entity or as a corporation. LLPs must file as a partnership and contain at least two members. Both of these are good options for your business if you want more flexibility in the management structure along with lower setup and maintenance costs.