As an entrepreneur starting a new business, you may find yourself drowning in decisions you must make. Deciding which type of business entity you will form represents one of your most important decisions.
Per the Internal Revenue Service, most businesses start in one of the five forms described in this article.
- Sole proprietorship
If you intend to own your company yourself, a sole proprietorship represents the simplest of all business entities. Basically, you and your business are one and the same. You have no start-up costs and can begin operations using your Social Security number as your business number. You will pay your company’s federal income taxes via adding a Schedule C to your own tax return.
If you intend to have one or more business partners, a partnership may appeal to you. Be sure to draft a comprehensive partnership agreement specifying each partner’s initial capital contribution and resulting ownership percentage. Each partner will pay his or her share of the partnership’s federal income taxes via adding a Schedule C to his or her tax return.
Forming a corporation entails submitting Articles of Incorporation to your state’s Secretary of State’s Office. You will also need Bylaws and a corporate seal. Because a corporation is its own separate legal entity, no shareholder has personal liability for its liabilities. On the other hand, a corporation requires you to pay double income taxes, one at the corporate level and the other at the personal level for your share of the corporation’s profits.
- S Corporation
You can set up your business as an S Corporation by making this election either at the time you start your company or any time thereafter. You avoid double taxation as an S Corporation because the respective shareholders pay their portion of the S corporation’s federal income taxes as though they were partners instead of shareholders.
- Limited Liability Company
If you choose to form a Limited Liability Company, this works the same way as a corporation with regard to taxes. However, an LLC gives you the ability to attract additional shareholders such as other corporations, other LLCs and foreign entities.