Setting up a new business means deciding on the type of business entity. Then, one or more individuals establish a business entity for the purposes of conducting business.
With 32.6 million businesses in the U.S., six types of entities are available to set up to trade. Of course, not every kind of entity is right for you, so let’s jump into your options and why you may want to choose them.
Sole Proprietorship
The sole proprietorship is the simplest type of business entity. The owner of the business is also the sole operator of said business. Under the law, if you begin trading as a business, this is what you legally are. There’s no need to register with anyone unless you require a local business permit or license. However, under the new Making Tax Digital for Income Tax Self Assessment (MTD for ITSA) initiative, you may be required to register for digital tax reporting if your business meets certain thresholds.
Freelancers and consultants most commonly establish sole proprietorships because it costs nothing in terms of time or finance.
You still need protection in place despite sole proprietorships being the only business type you don’t need to register. Due to the lack of limited liability protection, it makes business insurance more essential than ever. Taking out sole proprietors’ insurance will help protect your personal and business assets if someone decides to sue.
Investing in these protections now could save your livelihood further down the line. Alternatively, you could opt for a business entity that offers you more protection, such as the Limited Liability Company (LLC) or C-Corporation.
General Partnership
General partnerships share many of the aspects of the sole proprietorship. The difference is that two or more owners own the business. There are two types of partnerships, the general partnership and the limited partnership. The only difference is that within a general partnership, all partners are actively involved in managing the business and sharing in its profits and losses.
As the sole proprietor, there’s no need to register your business and no corporate formalities to account for.
However, the downside is that each owner is personally liable for the business’s debts. And some states will even hold all partners jointly accountable, even if only one partner was involved. It’s a concept known as several liability.
Like a sole proprietor, your personal assets are not protected if you’re unable to pay the business’s debts or you’re sued by a customer, employee, or creditor.
Limited Partnership
The limited partnership is a distinct business entity because it must be registered. In addition, you need to file paperwork with your state to create a limited partnership.
There are two types of partners within a limited partnership. Firstly, you have the general partners that own and operate the business. You also have limited partners, known as silent partners, who are exclusively investors and don’t assume any liability for the company.
Limited partnerships are ideal for attracting investment because investors don’t need to accept any personal liability. Moreover, a limited partner can leave the partnership at any time without forcing the dissolution of the business.
The downside is that these are more expensive to maintain than general partnerships and require filing returns with your state.
C-Corporation
Despite the name, there are more than 1.4 million C-Corporations with fewer than 500 employees registered in the U.S.
C-Corporations are separate legal entities in their own right. They’re considered separate from their owners, known as shareholders. All of these corporations contain a board of directors and various officers.
There are far more regulations and tax laws that apply to the C-Corporations. They’re more expensive to establish and require regular annual filings to maintain. You also need to be aware of the consequences of double taxation.
C-Corporations are viewed as more “legitimate” businesses and find it simpler to attract investors. Moreover, they have liability protection, allowing their shareholders to keep their personal assets separate from the company.
S-Corporation
An alternative to the C-Corporation is the S-Corporation. Technically, the S-Corporation is not a distinct business entity but a tax election. Therefore, owners of C-Corporations and LLCs may choose to be taxed as an S-Corporation.
S-Corporations are considered pass-through entities for tax purposes. All profits and losses pass through to the owner’s personal tax returns. There are no corporate taxes to pay, and you avoid the problem of double taxation.
However, you continue to maintain the benefits of liability protection. One aspect you have to consider is that there are limits on issuing stock, and they’re both expensive to register and maintain.
S-Corporations must also continue complying with corporate formalities, such as holding board meetings and creating a list of corporate bylaws.
To create an S-Corporation, you’ll need to file IRS Form 2553.
Limited Liability Company (LLC)
The LLC is the most common registered business entity. They come with limited liability protections to defend your personal assets, but they also lack mandatory paperwork. As a result, there are no corporate formalities to comply with, and you have the choice to decide how the IRS taxes your business.
LLCs may be taxed like a corporation or as a pass-through entity. The flexibility and relatively low cost of setting up this type of business make it a popular choice among small business owners.
Remember, LLCs are ideal for smaller businesses but lack the protections and functions of a growing business. For example, LLCs cannot issue stock or establish different stock classes. However, LLC owners can change their business type by filing a few forms later in their journeys.
Starting an LLC takes just a few hours, and the fees range from as little as $50 in some states to just a few hundred dollars. In addition, annual maintenance fees are much lower.
Conclusion
Deciding on the right type of business entity depends on the structure you want to operate under and how you want to run it. Limited liability protections are considered a must-have for businesses, for example.
You also need to think about how much paperwork you want to assume. Corporations always come with the most paperwork, so you must hire a professional to deal with it on your behalf.
What type of business entity do you think is best for you?
