Business formation is a long and complicated process, especially for a new entrepreneur. One of the first decisions that you’ll need to make is the kind of business structure you want to form.
The following are the most common types of business structures that entrepreneurs choose for business formation:
- Sole Proprietorships
- Limited Liability Company (LLC)
All of them have their own advantages and disadvantages. Before you decide on the right entity type, make sure you understand the implications of your choice on your business.
Business Formation: Which Factors Should You Consider While Choosing a Legal Entity?
Your choice will guide how you operate your business for years to come. That’s why it is a decision that you should take after thorough research and planning.
When you look at different entity types for business formation, here are some of the factors you should consider:
- Ease of formation
- Tax implications
- Ownership arrangement
- Legal liability protection
- Administrative expenses
Regardless of the entity type you choose, you can use a platform like GovDocFiling to get your business registered quickly.
When you use the platform, you only need to fill one application for state and federal filings for business formation. The expedited processing system makes sure you have a hassle-free experience.
Business Formation: What You Need to Know About Different Entity Types
Before you formally start any business formation procedures, you need to understand what each entity type has to offer. You can then compare these on the parameters that we discussed in the previous section.
In this section, let’s discuss the most popular entity types in detail.
1. Sole Proprietorship
A Sole Proprietorship is the simplest business structure in terms of the business formation paperwork. Other than your EIN (employer identification number) or Tax ID, the state does not require any additional formation process.
However, if you choose to run your business under a fictitious name, you will also need to file for a Doing Business As (DBA).
Sole Proprietorships can have only a single individual as their owner and follow a pass-through taxation system.
Sole Proprietors will have to show all the profits and losses of their business in their personal tax returns. They also need to pay a separate self-employment tax to the federal government.
In case of a lawsuit, the complete financial liability is on the owner and their personal assets can be seized if they fail to pay their debts.
2. Limited Liability Corporation (LLC)
Startups and small businesses often opt to form a Limited Liability Corporation because it limits their liability and protects their personal assets.
To form an LLC, you’ll need to file a document called the Articles of Organization. For this business formation procedure, you will need to pay some filing fees. The exact fees will vary for different states in the US.
The taxation structure for LLCs varies, depending upon the numbers of LLC members.
Single-member LLCs are taxed like Sole Proprietorships while multi-member LLCs are taxed like Partnerships. However, members can also decide to get their LLC taxed as a Corporation.
A Partnership is a legal entity in which two or more owners contribute their money, time, property, or labor before they share their business’ profits and losses.
For business formation, there is only one requirement for Partnerships — you need to get your Employer Identification Number (EIN).
Partnerships are easy to maintain because partners don’t need to file both corporate and personal taxes. They only need to report the profits and losses of their business as individuals. This arrangement ensures there is no double taxation.
A Corporation is a business structure that is formed by an individual or a group of individuals with a charter.
After its business formation procedure is complete, a Corporation has certain rights, powers, liabilities, and privileges. Such Corporations are also known as C-corps.
The legal formality can be completed from the office of the Secretary of State. Once formed, a Corporation has an indefinite lifespan and becomes its own legal entity.
The taxation arrangement for Corporations is relatively complex. The Corporation itself is taxed and the distribution of earnings that is given to the shareholders is also taxed on the shareholders’ individual tax returns.
However, owners can choose to pay themselves a year-end bonus or a salary to avoid the double taxation arrangement.
An S-Corporation is a good option for anyone who wants to form a corporation but wants to avoid double taxation. There are certain requirements to form an S-Corporation, including having fewer than 100 shareholders.
S-Corporations follow a pass-through taxation system, similar to Partnerships, LLCs, and Sole Proprietorships.
All the federal tax on an S-Corporation’s profits and losses is passed to the shareholders’ individual tax returns. This is one of the main differences between an S-Corporation and a general Corporation.
There is one main advantage of the taxation system in S-Corporations compared to Partnerships and Sole Proprietorships. They don’t have to pay any self-employment tax on their share of profits.
However, there are also some additional taxation requirements for S-Corporations. These vary for different states in the US.
Ready to Make a Choice?
Choosing the right legal entity is one of the most important business formation decisions. It will set the tone for how you conduct your business in the future. Use the information above to compare the pros and cons of different entity types.
Take into consideration the business’ operational needs, ownership requirements, and taxation process while making your decision.
Use this post as your business formation guide on how to choose the right business structure. All the best for your business formation process.
Brett Shapiro is a co-owner of GovDocFiling. He had an entrepreneurial spirit since he was young. He started GovDocFiling, a simple resource center that takes care of the mundane, yet critical, formation documentation for any new business entity.
Interesting Related Article: “S-Corporation vs. LLC Which one is Better for Your Startup?“