Last week's blog discussed why selecting the best business form for an individual business start-up is important. This week's blog focuses on a closer look at the different entity form options that may be available to business owners and new entrepreneurs. Entity form options can include sole proprietorships, partnerships, corporations, s corporations and limited liability companies. Each business type has important tax consequences and potential liability concerns to consider.
Sole proprietorships allow the profits from the business to flow directly through to the business owner's personal tax return and can be the simplest and least expensive business form to establish. The downside is the sole proprietors have unlimited personal liability. Partnerships involve two or more individuals that contribute to the business and share in its profits, as well as its losses. It is important to have a carefully thought out partnership agreement, as partners share joint and individual liability.
Corporations are owned by shareholders who have limited liability in relation to the corporation, however, corporate profits are taxed and shareholder dividends are also taxed. Corporations can be more complex to establish and may also be subject to more regulations and additional paperwork. S corporations, for companies that meet the requirements, can avoid taxation so that only the shareholders are taxed. Lastly, limited liability companies, provided for by statute in some states, are taxed similarly to partnerships but enjoy liability consequences similar to corporations.
Choosing the best business form for a start-up company is based on the specialized needs of the business and business owners. The business formation process can be exciting but also requires a careful understanding of the available options and specialized knowledge of how the different entity form options meet the business needs, goals and even anticipated challenges of the business.
Source: Minority Business Development Agency, U.S. Department of Commerce, "Choosing a Business Structure," accessed on Feb. 28, 2015