When starting a new business, choosing the correct business entity is one of the most important decisions. There are six main types of business entities in the United States, and each one has different legal and tax implications. Choosing the right one can help set a business up for success, while the wrong designation could have major financial consequences. If you are a business owner that is unsure of which business entity designation suits your needs, you can learn more by discussing your options with the experienced San Francisco business formation lawyers at Von Rock Law. Call us today at (866) 720-0195 for a free consultation.
Generally speaking, a business entity is an organization that is created to conduct business. A business can be created by either an individual or a group of individuals. The entity type that a company chooses will determine how the business is structured and how taxes are assessed to that business.
Choosing a business entity should be one of the first tasks handled by the founders of the business. This choice will have an impact on taxes and various legal aspects involved with operating the business. The amount of taxes the business owes to the IRS and local and state tax authorities will depend on which business entity the owners have chosen. It can also affect the process of applying for a small business loan and fundraising from investors. From a legal perspective, the type of business entity has liability implications if someone ends up suing the business.
In most cases, business owners in the United States must register under one of six main types of business entities. This decision will often depend on how the business is organized and how many owners it has. For example, a sole proprietorship is only available to businesses with one owner, while partnerships always involve multiple owners.
Sole proprietorships are the simplest type of business entity, as they only involve one owner (or a married couple). The individual or couple is the business’ sole owner and operator. Those who open new businesses as the only owner are legally considered sole proprietors automatically. They do not need to register the sole proprietorship with their state but may be required to apply for local permits and business licenses, depending on the industry. Freelancers and consultants are typically classified as sole proprietors, but other businesses with only one owner and operator also use this designation.
The main benefits of a sole proprietorship involve the simplicity of it, such as no registration requirements and comparatively simple tax requirements from the Internal Revenue Service (IRS). However, sole proprietors are exposed to more risk in terms of liability, as someone who wins a lawsuit against the business may recover the business owner’s personal assets, such as bank accounts and real estate properties. There is also no true legal separation between the owner and the business, which can make it difficult to receive a business loan and raise money from investors and lenders. You can learn more about sole proprietorships by contacting the San Francisco business lawyers at Von Rock Law.
A general partnership is similar to a sole proprietorship in many ways, but always has two or more owners. Like sole proprietorships, the owners of general partnerships do not need to register with their state, as this is the default structure for businesses with multiple owners. In general partnerships, all partners are actively involved with the management of the business and share in both profits and losses.
General partnerships share many of the same pros and cons of sole proprietorships. Both are easy to start, and the owners are not required to follow corporate rules and paperwork requirements. Unlike a sole proprietorship, the partners may deduct most business losses when they file their personal tax returns. Liability is also similar in both structures. In a general partnership, all owners are personally liable for business debts and other liabilities. Some states also hold each partner personally liable when another partner acts negligently. Additionally, similar to sole proprietorships, general partnerships also may run into difficulty when attempting to secure a business loan.
Unlike the previous two entities, limited partnerships require formal registration. Business owners who wish to form a limited partnership are required to file paperwork with their state. Limited partnerships involve two types of partners: the owner and operators who assume liability (aka general partners) and partners who are investors and nothing more (aka limited partners). Limited partners do not have any say in business operations, have fewer liabilities, and typically pay fewer taxes.
In a limited partnership, the owners often are more easily able to raise money, as investors can act as limited partners without the risk of being held personally liable. This allows the general partners to acquire the funding they need to operate and build the business. Limited partners can also leave the agreement at any time without putting the limited partnership at risk. For negatives, general partnerships are personally liable for debts and liabilities of the business. Limited partnerships are also more expensive to form compared to a general partnership and require paperwork.
C corporations are business entities that are legally separate from the owners of the company. Control of the corporation is split between shareholders (i.e., the owners), officers, and a board of directors. This type of business entity involves complex regulations and tax laws. The requirements and fees for incorporating vary between states.
The owners of a C corporation are not personally liable for the debts and liabilities of the businesses. C corporations also qualify for more tax deductions than all other types of business entities and the owners pay lower self-employment taxes. While they are more expensive to form, these tax benefits often offset the additional cost. However, the owners may not deduct business losses when filing their personal tax returns with the Internal Revenue Service and local tax authorities.
In an S corporation, all corporate income, deductions, losses, and credits are passed to the shareholders for federal tax reasons. The shareholders report the income and losses on their personal tax returns and are taxed based on individual tax rates. This system prevents double taxation on corporate income. However, shareholders are not personally liable for debts and liabilities. S corporations are also expensive to form compared to sole proprietorships and partnerships, but the financial benefits are usually worth the extra cost.
Limited liability companies offer many of the benefits of the other types of business entities, with fewer drawbacks. They enjoy the same limited liability protections as corporations, but usually involve less paperwork and fewer corporate requirements. The owners of LLCs also have the option to be taxed as a corporation or a pass-through business entity. Many small business owners (including freelancers) choose LLCs for their simplicity and legal protections.
If you are unsure which one of the common types of business entities suits your business or have any other business formation questions, Von Rock Law is here to help. Our experienced San Francisco business lawyers can evaluate your business and determine which option best suits your needs and preferences. Contact us today at (866) 720-0195 to learn more.