Choosing the right business entity type is an important step in starting a new business. Here is how you can pick the right legal structure for your business.
Opening a new business offers you a lot of fresh choices to make – from choosing a business name to a niche market, products or services to offer, and pricing labels.
But what’s the most important choice you need to make as a new business owner?
It’s choosing a legal business entity to form.
Business Entity Types: How to Choose the Right One
The business entity you choose will determine the paperwork you need to file, how much you’ll pay in taxes, and your personal liability. It will also govern how much flexibility you’ll have while operating your business.
The most common business entities are sole proprietorship, limited liability company (LLC), corporation, S-corporation, and non-profit.
Now the question is:
How can you choose the right fit for your business?
Let’s find out.
Which Factors Should You Consider When Selecting a Legal Entity?
Let’s start by analyzing which factors to consider when selecting a legal entity type for your business.
Here are a few key factors that should affect your entity choice:
- Legal liability
- Ownership options
- Tax implications
- Flexibility
- Other operational needs
- Formation and administrative expenses
- Costs
Reviewing the Most Popular Business Structures
Let’s take a closer look at the different types of legal business entities and what they have to offer.
Sole Proprietorship
A sole proprietorship is easy to form and gives you complete control over your business as the owner.
However, sole proprietors don’t create a separate legal entity, which means you’re personally liable for all financial obligations of your business. Your business assets and liabilities are not separate from your personal assets.
You will still get a trade name to operate your business.
But it can be difficult for you to raise funds as you cannot sell stocks and banks are also hesitant to lend money to individuals.
Pro tip: This business structure is best for those who want to test their business idea. Owners with low-risk businesses form sole proprietorships before forming a more formal business.
Limited Liability Company (LLC)
You can form an LLC as an individual or with partners as this business structure doesn’t restrict ownership. Owners of an LLC are called “members.” You can either register a Single-Member LLC or a Multi-Member LLC.
LLCs enable you to protect your personal assets such as savings account, home, and car from business liabilities and debts. If your LLC faces bankruptcy or lawsuits, you will not be personally liable for any of it.
As an LLC owner, you can show LLC profits and losses as your personal income through pass-through taxation. But you need to pay self-employment tax as well.
A limited liability company offers flexibility in the management structure of your business. As LLC members (owners), you can decide to choose between two management structures.
You can either run a Member-Managed LLC (where all members collectively make decisions) or a Manager-Managed LLC (where you appoint a manager who makes all major decisions).
Pro tip: LLCs are the best choice for medium- and high-risk businesses and for owners who have valuable personal assets to protect. You can also choose to form an LLC if you want to pay less tax than corporation owners.
Corporation
Corporations offer the strongest protection to your personal assets. But the cost of forming and operating a corporation is higher than other business entities.
Running a corporation requires that you do extensive record-keeping and reporting. However, it is easier to attract investors as you can sell stocks to multiple shareholders.
Corporations undergo double taxation, which means that they need to pay taxes on their profits. Then, shareholders also need to pay personal taxes on the dividends of the company profits they receive.
Pro tip: Corporations can be a good choice for medium- and high-risk businesses. Business owners who are looking for capital investment from outside sources should also form a corporation.
Regardless of the type of entity you choose, you need to complete the state and federal filing process to start your business legally. Many business owners find the formation process tedious and time consuming.
But the good news is:
You can now opt for business formation service packages from GovDocFiling? to simplify the process. They offer both state and federal filing, templates of other legal documents, and expedited application processing all with one easy online form.
But you need to finalize the entity type for your business first.
The Different Types of Business Entities: A Comparison
We’ve created this comparison table to make it easier for you to determine the right entity type for your business.
Take a look at it:
| Business Entity Type | Number of Owners Allowed | Personal Liability | Taxes to Be Paid |
|---|---|---|---|
| Sole Proprietorship | One | Complete personal liability | Personal tax |
| Limited Liability Company (LLC) | One or more members | LLC members are not personally liable | Self-employment tax Personal or corporate tax |
| Corporation | One or more owners | Owners are not personally liable | Corporate tax Personal tax on the dividends of company profits |
Did this table make it easier for you to understand the major differences between these common business entities?
Now that you’re more equipped to decide, it’s time to choose a business entity and register your company.
Ready to Form Your Own Business Entity Legally?
Choosing the right entity type will help you maximize your tax benefits and reduce your personal liability. You should consider what each of these legal structures offers and which one of them aligns the best with your business needs.
You can also consult with business formation experts and tax consultants to make this important decision. You should follow the best tips to build your business from scratch.
Do you have other questions about choosing the legal entity for your business? Ask them in the comments below.
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