Small Business Success: Choosing the Right Type of Entity
One of the first things that an entrepreneur needs to consider is what type of business entity they’re going to operate their new business in. Now there are a lot of different options. And it’s important to use a tax professional in making that decision because there’s no one size fits all opportunity here. And the number of shareholders that are involved, the type of financing that you need, even the access strategy, you’re going to play a role in that decision process.
For today though I want to do a quick overview of the most commonly considered entities that we see with entrepreneurs. The first is the sole proprietorship or sole prop. This is where you’re not actually filing a business entity but instead just stating the profit or losses on your personal taxes at your end. It’s important to note though because there’s no entity you are taking on more risk in terms of the liability. And similarly there is a partnership. This is basically the same thing as a sole proprietorship except for your splitting that profit or that loss for tax purposes between one or more parts. But again it does carry the same sort of liability risk as the sole proprietorship does. And then there’s the corporation. These are more complicated to establish but by incorporating, you’re protecting your personal assets because it is a separate taxable entity. And after you incorporate, you can choose to elect a status. This will make the entity pass through for tax purposes which means the shareholders are taxed instead of the corporation. But it still maintains liabilities protection.
It’s really common for a tax professional to recommend the structure because it allows an entrepreneur to take those tax losses that they may expect, especially in start up phase in the first years or when it actually happens as opposed to if you have a corporation, you carry those losses forward and offset future gains. And then finally there’s the LLC. The LLC is slightly easier to establish and maintain than a corporation, but it maintains the same type of liability protection. These are preferred structures for say real estate but not typically utilized for complex business structures; companies that are going to raise capital or go public.
The right entity will help you maximize your tax benefits while reducing your liability. So consider them carefully and again use a tax professional when making a decision.