The COVID-19 pandemic spurred many Americans to set out as first-time business owners. 2020 saw an increase in new business applications that greatly exceeded the year-to-year increase of any of the five years prior, and a record five and a half million new business applications were filed in 2023. As millions become first-time business owners, one of the principal questions at the outset of any new venture should be: “What is the best entity structure for my business?”
Often, selecting an entity structure is an afterthought. But, selecting an inappropriate entity structure can potentially result in substantial expenses to the business down the line, as the initial structure may not be the most advantageous. Individuals interested in starting a new business would be wise to work with legal counsel to properly structure the business at the outset, as there are many different entity structures that provide vastly different benefits, especially in regard to taxes and liability. Some of the most popular business entity structures include the following:
Sole Proprietorship
An individual that conducts business activities without officially forming a business entity with a Secretary of State or similar office, is presumed to be a sole proprietorship. Predictably, a sole proprietorship carries the lowest business formation expenses, but individuals considering this entity structure should understand that they are personally liable for the debts, obligations, and liabilities of the business. A sole proprietorship’s income or losses are reported on Schedule C of the owner’s personal tax return.
Partnership
Any two or more individuals or entities that co-own a business may structure the business entity as a partnership, of which there are a variety, including general partnerships, limited partnerships, and limited liability partnerships, to name a few. All the partners in a general partnership and the general partners in a limited partnership are responsible for the debts, obligations and liabilities of the business, while the limited partners in a limited partnership and all the partners in a limited liability partnership have “limited liability” (i.e., liability is limited to investment in the business). Partnerships, by default, are subject to pass-through taxation, meaning a partnership’s income or losses are reported on the personal tax returns of the individual partners.
Corporation
A corporation is a legal entity separate and distinct from its owners (one or more), called shareholders, that provides each shareholder with limited liability. Traditional C-corporations are subject to “double-taxation,” because the income of a C-corporation is first taxed to the corporation, and then again when that same income is distributed to shareholders in the form of a dividend. Shareholders must report dividends received on their personal tax returns. For tax purposes, certain eligible corporations may elect to be taxed as an S-corporation. The primary benefit of an S-corporation is the removal of Federal income tax at the corporate level, but S-corporations must be carefully structured and operated to maintain S-corporation status, and the state-tax benefits provided by an S-corporation vary from state to state. The obligation to follow “corporate formalities” generally results in corporations incurring higher formation and record-keeping expenses than other entity structures.
Limited Liability Company (“LLC”)
The most common new entity being formed is the LLC. LLCs provide one or more owners, called members, with the limited liability of a corporation, and the pass-through taxation of a partnership, though certain LLCs can elect to be taxed as C-corporations or S-corporations. LLCs are increasingly popular, as they are relatively less expensive to form and prove more flexible in operation when compared to corporations.
Each entity structure provides inherent advantages and disadvantages. It’s crucial for individuals embarking on the journey of starting their own business to have the support of legal counsel capable of facilitating the most advantageous entity structure for their business.
For more information or to seek counsel from our business & corporate attorneys, please reach out to request a consultation or call us at 216-696-1422.
