How to Pick the Right Entity for Your Business

Starting your own business is an exciting yet complex process. The choice of which business entity you choose plays a pivotal role. This decision impacts operational aspects, legal liability, tax requirements, growth potential, and much more.

Knowing the importance, your decision should consider factors such as desired control level, acceptable risk, and long-term objectives of your business. Understanding the unique characteristics of Sole Proprietorships, Partnerships, LLCs, or Corporations is crucial. Use this guide to help streamline your decision-making process, ensuring you select the best structure for your business.

What is a Business Entity?

A business entity is an organization that will conduct business. An alternate name to a business entity is a business structure.

Depending on the business entity chosen, the following aspects of your business can vary: 

What are the Types of Business Entities?

There are multiple business entities that you can select from:

A description of each business entity, its requirements, and what each business entity offers follows below.

Start Immediately: Sole Proprietorship

A sole proprietorship is the easiest business entity to form. As a sole proprietor, there's no difference between you and your small business. In fact, for liability purposes, they are the same.

Once you start a sole proprietorship, you'll be able to conduct business immediately. While it isn't a requirement, you may want to keep your business expenses separate from your personal expenses. You can do so by making a sole proprietorship bank account.

To form a sole proprietorship, you'll need:

DBA is an acronym for "doing business as." This is the name you'll use to register your business within your state. 

You must ensure that the name that you intend to use is available. Some states won't allow duplicate names or names that may cause confusion, so it is best to search databases. 

Depending on where you'll operate your sole proprietorship, you may have to certify your small business name every year or every two years. 

Sole proprietorships may need the following licenses to operate in their state: 

To file taxes as a sole proprietor, you'll use a Form 1040, a U.S. Individual Income Tax Return, and a Schedule C, Profit or Loss From Business. 

Work with Others: Partnership

A partnership is a business entity with at least two people who agree to operate a business together. Members of a partnership are partners that are either general or limited: 

Each partner is only liable for up to the amount invested in the partnership. There are different partnerships, each with differing levels of liability.

There are three partnerships that you can select from:

In general partnerships, partners involved will have unlimited liability. This means that if their partnership experiences legal trouble, both business assets and personal assets are at risk.

 Limited partnerships have at least two partners: 

Members in a limited partnership can also have limited liability. However, this applies only to the limited partners. Any of their earnings above the amount invested in the partnership isn't at risk.

Limited liability partnerships have at least two partners: 

As with limited partnerships, liability in a limited liability partnership can't exceed the amount used as an investment in the partnership.

To form a partnership, you'll need:

To form a partnership, you'll work with your state's Secretary of State. You'll need your partnership agreement completed, which determines your: 

Members of partnerships will use Form 1065, individually, for tax purposes. This Form, the U.S. Return of Partnership of Income, will report partners' credits, gains, income, or losses. 

Additionally, partners will use Schedule K-1 to report their share of the partnership's credits, deductions, and income. 

Liability Worries: LLC

An LLC, or a limited liability company, is another business entity that you can select. Some qualities that are unique to LLCs are: 

To form an LLC, you'll need the following:

The business name that you'll use for your LLC must be unique. It must not be an exact duplicate of an LLC in your state. Another requirement of LLCs is a variant of "LLC" in the name: "limited liability" or "LLC" are both acceptable.

In most states, you'll need a registered agent to form your LLC. This agent will be the person that collects your federal and state documents. The registered agent must live in the state that your LLC will operate. 

An Operating Agreement isn't a requirement for single-member LLCs. It's also not a requirement in many states. However, Operating Agreements can still be helpful. More information about Operating Agreements is available here.

Taxes for LLCs are simple: 

Attract Investors: S-Corp

The qualifications for businesses to become S-Corps are straightforward. For your business to become an S-Corp, it must: 

Corporations, non-resident shareholders, or individuals in a partnership don't qualify for S-Corp status. Certain financial institutions, domestic, international sales corporations, and insurance companies don't qualify for S-Corp status.

The following documents are the documents that you'll need to form your S-Corp:

The Articles of Incorporation for your S-Corp will require the: 

Corporate bylaws are the structures that determine how your S-Corp will operate. Your S-Corp's corporate bylaws should contain an overview of your corporation's: 

You'll need to file the certificate of incorporation with your Secretary of State or a similar state department if applicable. Upon doing so, it will designate that your company is a corporation within your state. 

The final step to form your S-Corp is to file Form 2553. This form must contain every shareholder's signature, and it must be dated by an officer who can sign on behalf of the corporation.  

Taxes for S-Corps are more rigid than other business entities. Only C-Corps or LLCs can become an S-Corp. For C-Corps businesses electing to become S-Corps, you must complete Form 1120-S. You must also have signatures from every shareholder to have it accepted by the IRS. 

For LLCs electing to become S-Corps, you'll need to file a Form 1120-S. Each owner of an LLC must fill out a Schedule K-1 for the Form 1120-S. This form will report a shareholder's credits, deductions, and income. 

Unlimited Growth Opportunity: C-Corp

Out of all of the business entities, C-Corps offers the most opportunity for growth. Members, called shareholders, can exchange money, property, or both for their corporation's capital stock. 

C-Corps are business entities that are separate from shareholders. There are no limits to the number of shareholders that can join. 

The following documents are the documents that you'll need to form your C-Corp: 

Articles of Incorporation are documents that you'll need to form your C-Corp. You'll need the following:

Shareholders will elect the Corporation's Board of Directors. Your Corporation's Board of Directors are the individuals that will be in charge of operating the corporation. If your C-Corp is new, the CEO or President can elect their shareholders.

Many states have name requirements for C-Corps. The business name must be available and unique. You'll also add a variant of "corporation," either "Corp" or "Corporation," at the end of the C-Corp name.

Finally, C-Corps offer shareholders to invest in either common stock or preferred stock. There are differences which depend on shareholders: 

If you choose a C-Corp, you should know about double taxation. Double taxation occurs when the corporation pays a federal tax, and shareholders pay an individual tax for the corporation's profits. Only C-Corps and their shareholders are subject to double taxation.

Which Business Entity is Best?

The business entity that is best for you will depend on your business requirements. There are factors, pros, and cons to each of the business entities you should consider before choosing your business entity.

All business entities except sole proprietorships require you to apply for an Employer Identification Number or EIN. 

Sole proprietors can use their social security number or apply for an EIN if they want. A sole proprietorship without employees won't need an EIN. 

An EIN is a unique, nine-digit number issued by the IRS to identify your business, and it is free to obtain. 

Work with a Professional

Selecting the right business entity is a crucial decision that affects your operation, liability, and growth. Each entity type - Sole Proprietorship, Partnership, LLC, S-Corp, or C-Corp, offers unique benefits and challenges.

Partner with 1-800Accountant's entity formation experts for tailored advice and assistance. Our expertise helps you make informed decisions, ensuring your business starts on a solid foundation, leaving you free to focus on your business's goals.