While establishing a business or new startup you have to select the entity type to make it a legal business. When you select a particular type of business entity you have to comply with the legal requirement.
The type of entity you select for your business depends on your business goal and what you want to achieve out of your business. Such as whether your motive is profit or not for profit, whether you are going online or in-store, and whether your business services base or product base.
Business Entity
An entity is a legal business you need to be bound to file and comply with all the legality, especially the Tax compliance it carries with itself.
When starting a business, you must first decide what form of business entity to establish. The entity type you select will decide which income tax return form you have to file. The most common forms of business are the sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC) is a business structure allowed by state statute.
According to IRS “Legal and tax considerations enter into selecting a business structure”.
If you are forming a business, you can choose from the following business entities:
- Sole proprietorship
- Partnership
- Corporation
- S-Corporation
- Limited Liability Companies (LLCs)
- Nonprofit
How to choose an entity type?
Choosing entity type is dependent on several factors as each entity has its own requirement, whether it’s Taxes, liability, and other legal requirements.
Here are the deciding factors for choosing entity type:
- Taxes
- Liability
- Record keeping
- Legal compliance
Sole Proprietorship
A sole proprietorship is for the single person starting a business, it is the easiest way for a business entity to form. For legal purposes, entity and person are treated singly.
You can start a business operation as soon as you establish a sole proprietorship. One necessary piece of advice that to keep a record of your personal and business transactions separately. Secondly, make separate accounts for the business and yourself.
Here are the requirements for a sole proprietorship
- Employer Identification Name (EIN)
- License or permit
- DBA or Trade Name
- Registration
- Sales tax and use tax permit
Partnership
A partnership is a formal arrangement by two or more parties to manage and operate a business and share its profits.
- The operation of the business is continued by single or multiple acting partners acting for all.
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:
- General partnership
- Limited liability partnership
- Limited partnership
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:
- One or more partners will be a general partner who will operate with unlimited liability.
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:
- All partners are general partners who will operate the partnership
- All partners in a limited liability partnership will share liability
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:
- Business agreement
- DBA or Trade Name
- Employer Identification (EIN)
- Licensing
- Sales tax and use tax permit (if applicable)
To form a partnership, you’ll work with your state’s Secretary of State. You’ll need your partnership agreement completed, which determines your:
- Name of the partnership
- Principal's Office
- Length of the partnership
- Purpose of the partnership
- Types of partners in the partnership
- Governing law (this is usually state law; you’ll make this definition as broad as possible)
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.
Partners are supposed to Schedule K-1 to report their share of the partnership’s credits, deductions, and income.
Corporation
Corporation Members are shareholders, and shareholders are separate from the corporation.
There are four requirements for corporations. A C-Corporation:
- Has a board of directors and shareholders
- Has a more complex structure than a limited liability company
- Is legally independent of its owners
- Is not a personal tax liability for its owners
Tax benefit of accounting student:
C-Corps has a lot of tax benefits for owners and shareholders. You may pay taxes at a lower tax rate if your business income falls into a lower tax bracket. There is another tax benefit in the form of expenses allowed to be deducted from income. The following are the available deductions for corporations:
- Bad debts
- Charity Donations
- Compensation of officers
- Depreciation
- Employee benefit plans such as insurance and pensions
- Rents
- Repairs and maintenance
Limited Liability Company
Limited liability companies, or LLCs, are the first business entity type that you can choose for your new or small business. There are different types of LLCs available to choose from: it might be
- a single-member LLC or
- LLC with multiple members.
The three main advantages associated with a limited liability entity/company are pass-through taxation and its liability is limited up to shared capital. The members can pass their profits and losses to their owners.
The third advantage of LLCs is their flexibility. For tax purposes, LLCs can be either single-member or with multiple members. Also, LLCs can file and pay taxes either as a:
- Disregarded entity single-member LLCs can opt
- Corporation applies to LLCs with multiple members
- The partnership applies to LLCs with multiple members
A disregarded entity is considered separate from its owner. If you’re the owner of a single-member LLC, you’ll report your earnings on:
S-Corporation
S-Corporations are another business entity that you can select for your business operation. There are five requirements to create an S-Corp. Following is the requirements for establishing S-corporation
- Be a domestic corporation
- Having members of not more than 100 members.
- Have only allowable shareholders, including individuals, certain trusts, and estates
- Have only one class of stock
- Not be an ineligible corporation, such as domestic, and international sales corporations, certain financial institutions, and insurance companies.
S-Corps shareholders can avoid double taxation associated with other business entities. This is because of a pass-through nature entity. Any Profits and losses of the entity are passed through to shareholders and can then adjust in their personnel tax returns.
S-corporations separate their owners from their businesses. Thus, protecting its personnel assets in case of liquidation and solvency.
Besides having many advantages there are disadvantages associated with S-Corps having several advantages, there are also disadvantages. To become S-corp your company must already be a C-Corp or an LLC. All Shareholders will do this through a shareholder election, which requires shareholders to complete Form 1120-S.
There are reasonable salary requirements for S-corp. Which owner or officers must comply and provide a reasonable salary even when profits are low.
Nonprofit corporations are the most specific business entity. A nonprofit is established for the following purposes:
- Education
- Charity
- Religious
- Scientific
- Literary
Because of the operation and motive of the nonprofit organization they can have an exemption from tax. Nonprofits' operations are similar to C-Corps regarding their organization requirements.
Work with a Professional
The entity type you choose for your business will have the legal and tax laws compliance impact. Work with professionals at Bookkeeping Pro services to make sure that you select the right business entity that suits your business operations.
