What is a Business Entity?
Choosing the right business entity, or legal structure, you operate your business out of is an important decision. Your choice of business entity will impact you in two major areas: tax liability and legal liability. Few choices you make will impact your business and taxes greater than your choice of entity.
So what exactly are we referring to when we talk about business entity? Your business entity is the legal structure you operate out of. When you hear people mention their corporation, or LLC, or say they are a “sole proprietor”, they are talking about their business entity. On top of the legal and tax ramifications we talked about above, your choice of entity will also determine things like what tax forms you file, how you pay yourself and what type of annual paperwork you file with the state and IRS.
What Are My Options?
There are four main options when it comes to your choice of business entity:
1. Sole Proprietor– This means you never filed any paperwork with the state or IRS, you just hit the ground running. In this format you and your business operate as one in the same. It is by far the simplest and cheapest option for setting up, but also exposes you to the most legal liability and offers no tax benefits.
2. Limited Liability Company (LLC)– In most states, an LLC can contain several owners or just yourself. The LLC operates very similar to a sole proprietor, except for one major difference; it separates the owners from the business for legal purposes. From a tax perspective, contrary to popular belief, the LLC offers no tax benefits.
3. S-Corporation– An S Corporation, or S Corp for short, is actually not an entity on its own. Instead, it is a tax election that an LLC or C Corp can choose to use. So, from a legal perspective, the S Corp operates exactly the same as an LLC; it separates the owners from the business. Where the S Corp shines is on the tax front. Unlike an LLC or Sole Proprietor, the S Corp is not subject to self-employment tax on the profits in the business. This can be a major tax savings for businesses operating at a profit.
4. C-Corporation– The C Corp is a traditional corporation and is classified as its own legal entity. As an entrepreneur, C Corp status has its pros and cons. For those looking for financing via VC or equity markets, this may be the right fit for you. With the recent tax law changes, there is more viability with the C Corp. Careful planning needs to be done before jumping into the LLC-S Corp status – always collaborate with your CPA.
Making this decision is an important one and can be stressful for a lot of entrepreneurs. Often times this decision cannot be undone without serious ramifications. That is why our advice is to talk that decision over with an accountant. They will be able to help you make the decision that is most beneficial to you and your business.