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You might not be aware of this but selecting the proper business entity is an incredible important part of being a business owner. Fortunately, we’re here to help you break it down and understand the pros and cons of the most popular business entity types. So whether you’re a one-person show, or have a team of twenty, we’ll help you figure out the best business entity type for your business. Spoiler Alert: Picking one at random isn’t going to help you. Business Entities 101

Before we dive into the different types of business entities, let’s first review how we establish the best entity for your business. First and foremost we look at the type of business, the size of the business, and the location of the business. Once we have those details established we work with the business owner to understand how much they want to risk and how they want to file their taxes. For example, if a business is on the small side and the owner does not require a lot of liability protection (like a freelance graphic designer), a sole proprietorship might be the best option. Alternatively, if the company is larger than a handful of people, an LLC or S Corp might be a better option.

What Is A Sole Proprietorship?

A sole proprietorship is a good option for a business that does not require a lot of liability protection. Very often, sole proprietorships grow into LLCs (Limited Liability Corporations). While it sounds like a one-person show, a sole proprietorship can have employees, but it is important to remember that the business will need to pay income taxes.

  • Pros of a Sole Proprietorship:

    • The business owner does not need separate personal assets from the business assets.

    • If it is a one-person show and there are no employees, there is no need to pay for unemployment tax on your own income.

  • Cons of a Sole Proprietorship:

    • Self-employment tax is due on the net income of the company

    • You risk losing your personal assets in order to cover debts or lawsuits connected to your business. This means that the business is subject unlimited liability

What Is An LLC?  

A Limited Liability Company means that business and personal assets are always separate. While it can certainly have one or more members involved in “ownership,” the members personal assets are usually protected from business creditors.

  • Pros of an LLC:

    • Personal assets are usually protected from the business in case of a lawsuit or incurs debts.

    • An LLC is a pass-through entity, which means its profits go to its members without being taxed by the government at the company level

    • It is easy to start an LLC. The process is relatively simple for owners to handle and LLC management can be flexible.

  • Cons of an LLC:

    • If something goes awry and the business gets brought to court, the LLC will not necessarily protect the members personal assets if business and personal assets were commingled.

    • Members can be taxed under self-employment tax.

    • If something happens to a member, the LLC is responsible for the remaining legal and financial obligations to terminate the business and start from scratch is they still want to do business together.

What Is An S-Corp?

S-Corps are considered a “pass-through entity” and not taxed directly -- rather the income reported on the owner’s personal tax returns is taxed. Owners of an S-Corp are able to better control self-employment taxes and possibly minimize those (versus an LLC).

  • Pros of an S-Corp:

    • No double taxation—your personal assets are protected from the business should there be insurmountable debt or a lawsuit.

  • Cons of an S-Corp:

    • When raising money and adding investors, S-Corps are less flexible than a C-corp because it has more restrictive rules on who can be investors.

As you can see, there are many things to think about and consider when selecting a business entity—and we haven’t even talked about the paperwork or the process involved in setting it up officially with the IRS. At Accountfully, we have the pleasure of working with business owners and helping them make smart decisions that will positively impact and support their business. Selecting the business entity is just one of the many ways we do that. If you are interested in learning more about business entities and whether or not your current entity is the best option for you, let us know. We are always happy to hop on a call and compare notes.

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