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How to Choose the Right Type of Small Business Entity in 2022

We help you learn about the fundamental types of businesses to make the right decision in creating your small business.

Liara Cohen
Liara Cohen
August 15, 2022

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What Are Business Entities?

When starting a company, you can pick from various business kinds. Each has its own unique legal structure and set of laws that are to be followed. 

Sole proprietorships, limited liability companies (LLC), general partnerships and corporations are the four main forms of enterprises. 

Entrepreneurs should assess business structures to find one that is the most suitable to them.

This article will summarize these four fundamental types of businesses to assist entrepreneurs in making one of their most essential decisions.

“The sort of entity you pick for your business influences how your company operates and is taxed.”

Types Of Business Entities: An Overview

At its most fundamental a business entity is just an organization that has been created to do business. 

The sort of entity you pick for your business influences how your company operates and is taxed.

A sole proprietorship for example must be owned and run by a single person. If your company entity type is a partnership this indicates you have two or more proprietors.

Similarly, if you start a firm as a sole proprietorship you're a pass through organization for tax reasons. 

If on the other hand you incorporate your company it implies that the company operates independently of its owners. And as a result, pays separate taxes.

In general, you'll need to register your business in the state where it's located to establish its entity structure. 

The six most prevalent alternatives for business owners are sole proprietorship, general partnership, limited partnership, LLC, C corporation or S corporation. 

We've discussed each of these prominent business entity structures below. As well as the benefits and drawbacks of using each structure for your organization.

How to Choose the Best Business Entity Type

Sole Proprietorship

A sole proprietorship is an unincorporated business owned only by one person. While it is the simplest of the company kinds it also provides the least financial and legal protection to the owner. 

Unlike partnerships or corporations, sole proprietorships do not create a separate legal identity for the firm. Essentially the business owner has the same identity as the corporation. 

As a result, the owner bears full responsibility for any obligations incurred by the firm.

If entrepreneurs want to keep complete management of the firm, they may select this option. Furthermore, forming a single proprietorship is a simple and affordable process. 

There are additional tax advantages because income is considered the owner's income and is thus taxed only once. Finally sole proprietorships are subject to few regulatory restrictions.

General Partnership

Partnerships are similar to sole proprietorships in many ways. The main distinction is that the firm includes two or more owners. 

General partnerships or GPs and limited partnerships or LPs are the two types. All partners in a general partnership actively run the firm and participate in the profits and losses.

Like a sole proprietorship a general partnership is the default mode of ownership for multiple-owner enterprises. There is no need to register a general partnership with the state.

The majority of individuals create partnerships to reduce the risk of beginning a business. Having many people share your problems and accomplishments may be beneficial instead of tackling it alone. Especially in the early years.

If you choose this path then you must select the correct partner or partners.

Limited-Liability Company

Limited liability corporations (LLCs) are one of the most adaptable company structures. LLCs are hybrids that incorporate elements of both partnerships and corporations like Anheuser-Busch

They keep the tax advantages of sole proprietorships and the restricted liability of corporations. LLCs have the option of choosing between several tax regimes. 

The LLC preserves its flow-through taxation status if it decides not to be recognized as a C corporation. Furthermore, LLCs have the benefit of restricted liability. 

The corporation operates as its legal entity under LLCs. This shields the LLC owners from personal liability for the company's activities and obligations.

S Corporation 

An S corporation retains the restricted liability of a C corporation while acting as a pass-through organization for tax purposes. 

This implies that as a sole proprietorship or partnership the income and losses of an S corp are passed through to the owners' tax returns. An S corporation is not taxed at the corporate level.

You must submit IRS form 2553 to incorporate an S company or convert your firm to an S corporation. 

S corporations are a suitable option for companies that desire a corporate form but prefer the tax flexibility of a sole proprietorship or partnership.

A couple of female entrepreneurs stand together as partners of their small business
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The Summary Of Business Entities

You can now select which kind is suitable for your small business. Based on a greater grasp of how the basic business entity types function and their various benefits and drawbacks. 

If you can afford it the best course of action is to speak with a company lawyer. As well as a tax specialist. This will help you determine which structure is ideal for you. Consider where your firm is now and where you plan to take it.

First there are three fundamental aspects to consider when deciding between company organization types. They include legal protection, tax treatment and paperwork obligations. 

You may see how the entities compare in each of these categories in the section below.

Sole Proprietorship 

Limitations on Liability? No

Taxation: Taxed at the personal tax rate

Governmental Requirements: Low

Partnership In General

Limitations on Liability? No

Taxation: Taxed at the personal tax rate

Governmental Requirements: Low

Company With a Limited Liability

Limitations on Liability? Yes

Tax Treatment: You have the option of choosing how you wish to be taxed

Government Requirements: Moderate

The S Corporation

Limitations on liability? Yes

Taxation: Taxed at the personal tax rate

Governmental Requirements: High

The Bottom Line

The entity you choose for your business is critical. The entity you pick may influence how others see your company. And it has a significant impact on your legal exposure and money.

Conclusively, there is no one optimal business entity choice for all small enterprises. But by contacting legal or financial specialists and referring to this guide. You may be able to identify which form is suitable for your organization.

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