What is a business entity? Business structures to consider

What is a business entity, and why does it matter to your business? The first step toward answering this question is to learn about the various types of business entities and each one’s requirements and protections. A business entity is simply the legal structure of a business, such as a sole proprietorship, S corporation, C corporation, LLC or partnership. Business entity type impacts every aspect of a business, from legal liability to tax obligations, financing and operations.

Start the process of making a decision by reading about five types of business entities below. Check with an attorney, accountant or financial advisor before selecting a business structure.

Types of business entities

Sole proprietorship

A sole proprietorship is a simple business structure that’s easy to establish. In a sole proprietorship, the business owner and the company are considered the same entity. As a result, profits and losses flow directly to the owner and are taxed on a personal tax return without the need to file business taxes.

Sole proprietorships are a popular choice for small companies run by one person, such as consultants, freelancers and small retailers, since they do not involve the time and money required to establish a corporation or draw up a partnership agreement. The flipside of this simplicity is the lack of liability protections associated with some other business structures. Since business and owner are one, all liabilities in a sole proprietorship — think lawsuits or debts — are the personal responsibility of the business owner. In addition, lenders base decisions on a sole proprietor’s personal credit history if the business applies for financing.

Some sole proprietors choose to register for a “doing business as” (DBA) name to create a distinct identity for marketing and sales. For example, independent florist Sarah Smith might decide to run her business under the name “Smith’s Floral,” or a consultant could establish and brand themselves as “Strategic Solutions.” If choosing not to register a DBA, you only need the required licenses and permits for your type of business, often making the process of establishing a sole proprietorship quicker than setting up another type of business entity.

S corporation

Establishing a corporation requires some effort and investment, but in return it delivers liability protection and tools for growth and credibility. An S corporation, often referred to as an “S corp,” is a separate entity from its owner or owners, offering a layer of protection for personal assets in the case of lawsuits and business debts. S corps and C corporations (“C corps”) provide similar liability protections but are different in a few key ways. An S corporation may issue stock, but it can only have a maximum of 100 shareholders — individuals, not business entities — and those people must be U.S. citizens or resident aliens. S corps must also be domestic companies in certain industries. Insurance companies, domestic international sales corporations, and certain financial institutions cannot be S corps.

The other big difference between S and C corps is taxation. An S corp offers “pass-through” taxation, meaning that profits and losses pass through to individual owners’ personal tax returns. In simple terms, this means at tax time, S corp owners pay individual, not corporate tax. C corporations are subject to corporate taxes, and owners or shareholders may then also be taxed on any salary or dividends.

To form an S corp, a business must choose a name, file articles of incorporation, allocate corporate stock, choose directors, obtain an Employer Identification Number (EIN) — which serves as a corporate Social Security number — and file other associated paperwork. Most people use the help of an attorney to create an S corp.

C corporation

C corporations, also known as “C corps,” are separate legal entities that provide flexibility in the type of allowed stock and shareholders. Like an S corp, C corps provide limited liability protection for shareholders’ personal assets from lawsuits and debts, unless shareholders break the law or fail to follow corporate guidelines. Unlike an S corp, C corps can have individuals or business entities as shareholders, and there are no U.S. citizenry requirements for shareholders. C corps can also issue different types of stock to an unlimited number of shareholders, which may help with raising capital.

C corps are also taxed differently from S corps and some other entities. C corps face corporate taxes, and shareholders pay personal income tax on any dividends, resulting in what is often called “double taxation.” C corps may have advantages, too, so speak with a tax professional to fully understand the implications of choosing between an S and C corp.

Forming a C corp requires many steps, including filing articles of incorporation, choosing directors, allocating corporate stock and planning to meet the requirements to hold annual shareholder meetings, maintain a board of directors and follow other formalities. It is advisable to seek the help of an attorney when setting up a C corp.

Limited liability company (LLC)

An LLC is a business structure that an individual or group of people, called members, can form to gain liability protection and flexibility. Like a corporation, an LLC provides liability protection for its members’ personal assets, such as money or property, in case of a lawsuit or debt. LLCs can be run by one person or multiple people, making them more flexible than a limited liability partnership (LLP), which must have more than one owner. Unlike a sole proprietorship, LLCs can include a large number of people, companies, or other entities as owners. These members can have varying degrees of involvement, from full operational responsibilities to financial investment only. LLCs can sell equity but may not issue stock. 

LLCs also have flexible taxation options. Like sole proprietorships and S corporations, LLCs are taxed on a pass-through basis, which means members pay personal taxes on all profits. However, the option exists to have an LLC taxed as a corporation or to designate different types of taxation for various members. Work with your tax advisor to determine the best option.

To form an LLC, choose a name and confirm with the Secretary of State’s office that it is not already in use, create and file articles of organization to establish your LLC in your state of operation, and establish an EIN. If you have a DBA name already, you may use this as your LLC name as long as it is not taken. LLC formation also requires the help of a registered agent to receive your documentation. It is advisable to create an operating agreement to spell out how decisions will be made, assets will be shared, and disputes will be handled, but it is not a legal requirement. Operating agreements are usually created with an attorney’s help, since some state guidelines stipulate how LLCs must be established and governed.

Partnership

In a partnership, two or more people share ownership of a business. Business partnerships are typically quicker and less expensive to form than corporations, but unlike a corporation or LLC, partnerships do not establish a separate legal entity. Instead, the roles, responsibilities and liability of each partner depend on the type of partnership and the details spelled out in a partnership agreement.

The appeal of business partnerships is the pooling of professional expertise and financial resources that can contribute to business-building momentum. Business partnerships are popular among groups of people with similar expertise and training in one field, such as accounting, finance, medicine or law.

A partnership may provide tax advantages compared to a C corp, since profits and losses are typically passed through to partners’ personal returns and the partnership itself does not pay corporate tax.

Use the list of partnership types below to learn more.

• General partnership (GP): Each partner has personal responsibility for what other partners commit to or engage in.
• Limited partnership (LP): At least one partner must be a general partner and assume full personal liability, financial and other. At least one other is a limited/silent partner who contributes capital but is not involved in business operations.
• Limited liability partnership (LLP): Limited liability partnerships (LLPs) limit the liability that each partner assumes for the other partners.
• Limited Liability Limited Partnership (LLLP): LLLPs spread liability across all partners to limit general partners’ liability and are only available in some states.

States may vary in the type of partnerships allowed, which could limit your partnership options if you operate in more than one state.

Learning about the requirements and protections of the various business structures can set you up to make the best choice for a strong start in a small business. Create a strong financial foundation too by establishing a business checking account. A business checking account can contribute to business credibility, keep business and personal finances separate, and streamline financial management. Look for an account that offers mobile banking, overdraft protection, and invoicing and accounting tools.

Ready to take the First Step?

When forming any type of business, a business checking account is an essential first step to deposit, move and borrow money for your business. With a Citizens business checking account, you’ll have all of the features you need to manage your business’s finances.

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