Business Entity Types

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.

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