subject: What Kind Of Business Is Best For Me? Pros and Cons of Different Entity Types [print this page] What Kind Of Business Is Best For Me? Pros and Cons of Different Entity Types
The best entity type for your business is not a simple answer; it's important to look at the pros and cons to determine the best option for your unique situation.Review this brief overview of the various entity types to determine what kind of business is best for you.
Sole Proprietorship
This is the simplest entity type there is; it's a DBA, meaning it's simply an individual doing business as a name other than his or her legal name.
The pros: A Sole Proprietorship is the ultimate in simplicity. Formation is a simple form filed with your state or county; that filed document allows you to open a bank account under the assumed name. Additionally, there's no need to get an EIN, or federal employee identification number -- you can use your social security number, since there's no legal separation between you and the company.
The cons: While the lack of legal separation between individual and business can be convenient, it can also be a detriment: if the business defaults on a loan or is sued by a consumer, you're personally 100% liable.
Partnership
Like a Sole Proprietorship, an unincorporated Partnership is a DBA. It's a simple structure allowing more than one person to do business together under a name other than their legal names.
The pros: Just as with a Sole Proprietorship, a Partnership is a very simple structure.
The cons: In addition to the personal liability inherent in an unincorporated Partnership, a possible con might be that both owners have equal authority over the business -- in the event of a disagreement, there's no one to settle a dispute. If one partner wishes to make a business decision, there's no requirement that he or she consults the other partner.
Corporation (for-profit)
A corporation is different from the DBAs in that it isn't simply another name for a person or persons to operate under -- it's a new "person" entirely. To form a corporation is to form a separate legal entity entirely, capable of entering into contracts, suing, and being sued.
There are two types of corporations, each with their own pros and cons: a C corporation, and an S corporation. A C corporation is the default type of corporation; an S corporation is required to send a form to the IRS in order to declare their "S" tax classification.
C corporation pros: This type of corporation is very flexible in structure; there can be an unlimited amount of shareholders, and those shareholders can be US citizens, non-citizens, or other corporations.
C corporation cons: Because of the tax structure of a C corporation, the income is taxed on two levels in what is known as "double taxation." Here's how it works -- the corporation's profits are taxed once, as corporate income. Then the remaining profits are taxed a second time, on the individuals' tax returns, as individual profits. Therefore, a larger chunk is taken out of the profits as both corporate and personal taxes.
S corporation pros: An S corporation avoids the double taxation described above by being taxed only once, at the personal level, as individual profits. There is no corporate tax in addition to this, which results in a lower tax responsibility than with a C corporation.
S corporation cons: The structure of an S corporation is more limited than with a C corporation -- owners must be individuals, not corporations, and they must be US citizens or resident aliens.
Nonprofit Corporation
A nonprofit corporation is just as it sounds -- a corporation that does not bring in income.Many nonprofits that are educational, charitable, scientific, or religious in nature go on to obtain 501c3 status at the federal level; this step occurs after the corporation itself has been formed at the state level. Only after a corporation has obtained the 501c3 status can it begin accepting tax-deductable donations.
The pros: Nonprofit corporations, in many states, enjoy lower filing fees than their for-profit counterparts. Additionally, nonprofit corporations accepted for 501c3 status enjoy further discounts and exemptions on things like taxes, postal rates, and more.
The cons: Obviously, a nonprofit corporation does not make a profit. Owners will not become fabulously wealthy through their business endeavors.
Limited Liability Company
A limited liability company, or LLC, is a unique entity type that is neither a corporation nor a partnership, but carries some of the advantages of both.
The pros: An LLC has the same structural flexibility as a C corporation -- unlimited ownership, with both US citizens and non-citizens alike eligible to be an owner. Personal liability is limited. Additionally, an LLC has options with the IRS as far as how they wish to be taxed.
The cons: An LLC can be subjected to a special tax in some states, and there may be higher restrictions on the types of businesses that can organize as an LLC.
It's important to determine the best entity type for your unique situation. For example, if your business does not require a lot of startup capital or inventory and could be run out of your home, a Sole Proprietorship or Partnership could be a great option for you. If you're going to be taking out a loan for your business or entering into contracts, you might decide that limiting your personal liability is more important.
Whatever you decide, do your homework and make sure you're taking into account the future of your business, not just startup costs and simplicity!
