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5 Tips to Choose the Right Business Entity

Published By Janet Gershen-Siegel at April 24th, 2018

Do you know how to choose the right business entity for your company? We show you how to do it – it’s easy!

This is your decision to make. Pay close attention to the tax burden and personal liability as they can affect you, particularly if you have a business with known hazards, such as carpentry or exterminating. You might also want to consider how much control you want to have over your small business. A sole proprietorship means you call all the shots, but it also means you’re responsible for everything. That can be too much to handle. If it is, then consider one of the other common business entities for a small business.

5. Taxes

Business entities differ when it comes to how the IRS treats them for tax purposes.

Here are the specifics:

  • Sole proprietorship – because the single owner and the sole proprietorship are the same; the owner pays taxes on the sole proprietorship’s profits.
  • Partnerships – The partnership does not pay income tax. Rather, the business passes its profits or losses to its partners. Then the partners include their respective share of partnership income or loss on their personal tax returns.
  • Corporation – Corporations pay state and federal taxes, and they sometimes also pay local taxes. This includes income taxes on profits. A corporation can be taxed twice: first when a profit is made, and second when dividends go to the shareholders.
  • S Corporation – an S corporation can often be a smart choice for tax savings purposes. LLC members must pay an employment tax on the whole net income of the business, but only the wages of an S corporation shareholder who is an employee are subject to employment tax. Any other income goes to the owner as a distribution. Distributions are taxed at a lower rate, if at all.
  • LLC – an LLC does not exist as a separate entity according to the IRS, so it does not pay taxes. Instead, the members are individually taxed.

4. Legal Liability

Legal liability varies when it comes to business entities.

  • Sole proprietorship – because the company = its owner, there are no limits on personal liability. If the sole proprietorship did it, then so did its owner. You are responsible for all debts and obligations, and including any risks from actions of employees.
  • Partnerships – Partnership owners will have full, shared liability. Hence partners are liable for their own actions and for any business debts and decisions made by the other partners. Furthermore, the partnership’s debts can be satisfied via all of the partners’ personal assets.
  • Corporation – In a corporation, the shareholders’ personal assets have protection. Shareholders are usually just held accountable for their investment in company stock.
  • S Corporation – In an S corporation shareholder’s personal assets, like their personal bank accounts, cannot be used to satisfy any business liabilities, like verdicts against the company.
  • LLC – LLC members are protected from personal liability for business decisions or actions of the LLC. So if the LLC incurs debt or it is sued, members’’ personal assets are usually exempt. But not always, hence the term ‘’limited liability’.

3. How big is the company?

It may seem obvious, but an individual owner cannot be a partnership and vice versa. Very large companies tend to be incorporated, due to the first two tips listed above. A corporate structure can save individuals from both tax and legal liabilities – most of the time.

2. How will the profits be split?

Of course, if there’s only one person, then there’s only one split – e. g. no split at all. But what about when it comes to partnerships? They do not have to be split evenly. However, that is the assumption so, unless the specifics are spelled out in the partnership agreement, it is assumed the split is an even one.

As for corporations, the split is dictated by the percentage of shares owned by the stockholders, and the total number of stocks. A corporation with 100 shares and 100 shareholders isn’t much different from a regular partnership when it comes down to profit distribution. However, corporations tend not to be run that way. Instead, in a corporation, the biggest shareholders either have a seat on the Board of Directors or they control a seat where they have installed someone on the board who will fulfill their wishes. Hence in a corporation with 100 shares of stock, the board might consist of three people who each have 20 shares, with the remaining 40 shares being distributed evenly amongst other shareholders who have smaller percentages of the whole.

1. Control

Finally, how do you want the business to be controlled? Will it be one person calling the shots? Will partners informally divide the work amongst themselves? Or will a Board of Directors take a more formal approach, with annual meetings which the other shareholders are invited to?

Business entities can be changed. None of these decisions is set in concrete, particularly as companies grow and shrink all the time. The Internal Revenue Service is well aware that circumstances can force all sorts of changes. This can be anything from the death of a partner to a lawsuit against a member of a corporation’s Board of Directors. If you need to change your business entity, you’d hardly be the first business owner to do so. It’s never too late to switch to the correct business entity. Share this and tell your friends what you think of how to live your best financial life.

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