Types of Business Entities

When looking to form a business, it is important to understand the different types of business entities. Following is a summary of the five basic types of business formations.

Sole Proprietor:
 Easy to set up – no costs or legal requirements to set up and operate
 No personal limited liability protection, all assets are available to satisfy debts of the business
 No double taxation, report on your personal tax return using schedule C, E, or F
 Pay self employment tax on any income, which covers the employers and employees share of Social Security and Medicare tax

Partnership:
 Made up of two or more partners, no limit on the number of partners
 Formed by filing with the Secretary of State
 Easiest to set up, besides the sole proprietorship
 Files form 1065
 Partners get guaranteed payments instead of salaries, which subjects them to self employment tax
 No double taxation, the income passes through to the partners and is reported on their personal tax return, on which the partner pays self employment tax
 The income and losses can be allocated to the partners in any reasonable way
 No personal limited liability protection, unless the partner is a limited partner in a limited partnership
 A formal partnership agreement is recommended, but not required

Limited Liability Company:
 Formed by filing with the Secretary of State
 Members have limited liability
 No limit on the number of partners
 Can file a 1065 to be taxed as a partnership, or elect to be treated as a corporation
 A single member LLC does not require a separate tax return and still protects liability
 Proper business procedures must be followed in order to maintain the limited liability protection
 Income passes through to the members, which is most likely subject to self employment taxes depending on the type of business conducted

Corporation:
 Most strict formation and maintenance requirements
 File with the state to be recognized as a formal business entity
 Should pay shareholders salaries
 Taxes are paid at the corporate level
 Any distributions are not deductible by the company and are taxable to the shareholders at dividend rates
 Shareholders have limited personal liability as long as proper legal format and business procedures are maintained
 Insurance costs deductible for shareholders and employees
 Difficult and costly to get corporate assets out if needed

S-Corporation:
 A hybrid of the LLC and the Corporation
 Income passes through to the shareholders, is not taxable as self employment income
 Difficult and costly to get corporate assets out if needed
 Files with the state to be recognized as a formal entity
 Created by forming a C-Corporation and then electing to be treated as an S-Corporation, or forming an LLC, checking the box to be treated as a corporation, and then electing S status
 Shareholders need to pay themselves a reasonable salary, and can also take distributions of income
 Losses are only deductible if the shareholder has basis
 Shareholders cannot participate in pretax insurance plans or most fringe benefits
 Can have from 1 to 100 members
 Shareholders have limited personal liability