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There are several business entity types. Legal protection is is a very important
consideration when deciding what legal form a business entity should take.
You should learn all you can about these choices. You should
also know when to turn to experts who can help you understand issues you may not
have even known existed. You should talk with an attorney and a tax pro for help
with specific legal and financial questions that could affect your own venture.
This table gives you a thumbnail sketch of some of the characteristics of
various business entities — sole proprietorships, general partnerships, S
Corporations, C Corporations and Limited Liability Companies. What's Good
and Bad about each business entity type.
Check your state's Department
of Revenue and Secretary of State for specific filing requirements and tax
obligations.
Sole Proprietor
Pro: Easy to set up, easy to run, the easiest for first-time entrepreneurs to
understand, and the easiest to get out of.
Con: Unlimited personal liability, 15.3% self-employment tax on
all earnings up to $80,400.
Partnership
Pro: A good way to participating in a venture with other individuals without
having to deal with payroll issues; partners can also get "unequal"
distributions of income if all parties agree.
Con: Liability for the financial actions of all your partners in
the partnership; ordinary income from the partnership is subject to
self-employment tax; tracking of partners' capital accounts balances can be
complicated.
S Corporation
Pro: No Social Security or Medicare taxes on profits or dividends from the
corporation to shareholders.
Con: Can't fully deduct your own health insurance or benefits
plan costs (only those of employees); you also lose most of the benefits of the
home office deduction even if that's the only place where you operate your
business entity type.
C Corporation
Pro: 100% deductible health insurance for employees, including shareholders;
potentially fully deductible medical reimbursement and fringe benefits plans for
all employees, including shareholders; profits of up to $50,000 annually are
taxed at 15% if retained in the corporation rather than at your, potentially
higher, personal income tax rate.
Con: If the corporation loses money, you don't get to deduct it
on your personal tax returns; if profits that have been already taxed at the
corporate level are later distributed to you as dividends, you'll have to again
pay tax on that money.
Limited Liability Company
Pro: Owners of this business entity type get the limited liability features of a
corporation combined with the income-splitting flexibility of a partnership; a one-person
LLC can report income on a Tax Form Schedule C with personal tax
returns.
Con: Owners get stuck with the same self-employment tax
treatment as partners and sole proprietors; states may differ in their tax
treatment of LLCs; lawyers worry that there is little case law for what happens
when an LLC formed in one state gets sued for something that happens in another
state.
Read about the specifics
of Limited Liability Companies (LLC)
Information about the LLC
Operating Agreement.
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