Ready to advance your business to the next level? Then, you probably are ready to upgrade your small business into an entity. A business entity is simply an organization made up of one or more people to conduct, you guessed it, business. A business entity’s practices must comply with its state laws and in some cases, may have to file documents with the state’s agency.
There are four main entities a business can fall under—sole proprietorship, LLCs, partnerships, and S corporations— and each can present different advantages and disadvantages for you.
Want To Fly Sole? Try A Sole Proprietorship!
A sole proprietorship, also known as a sole trader, is exactly what it sounds like. It is a business entity that only has one owner. With a sole proprietorship, you’ll be the one paying personal income tax on business profits. This business entity is best for anyone who wants complete ownership of their business, like being the sole owner of a bookkeeping company or small retail shop. A sole proprietorship is also good for anyone who likes to work independently such as freelance writing and artists.
However, as a sole trader, you would be solely responsible for any debt or liabilities that come your way. Also, since there won’t be someone overhead to set official working hours, you have to be mindful of making sure you set clear-cut boundaries on when to work and when it’s time to relax.
Love Working In A Team? Try A Partnership!
Unlike a sole proprietorship, a partnership is a business that involves two or more people. All of the business’ contributions and work are divided up among the partners, with each person getting a percentage of the total business equity. To ensure everyone knows how the business should be run and who needs to do what, partners will sign a partnership agreement. Partnerships are also “pass-through” taxing entities, meaning income taxes are passed through to the owners and reported on their personal tax returns.
Partnerships are great for anyone who wants to start a business with colleagues or needs more hands on deck to keep everything afloat and running. Money and resources can all be pooled in from more people as opposed to one person. Since the business is shared, however, debt and loss from one owner can affect the other owner as well. Liabilities can also pose a threat to partnerships as well. And if partnerships are not on the same page with how the business should run, then disagreements can arise.
Looking For Liability Protection? Try An LLC!
For those wanting liability protection for their small business (like us!), LLCs provide such a thing! Hence the name LLC—limited liability company. LLCs can have one owner, which is referred to as a single-member LLC, or multiple. Regardless of if it’s one person or multiple, the LLC will still have liability protection. LLCs, like partnerships, are also pass-through tax entities. Multiple-member LLCs can choose whether to tax their business as a partnership or corporation, and single-member LLCs are taxed just like sole proprietors.
Transitioning your business as an LLC can be expensive. According to Forbes, the cost of registering an LLC can cost anywhere between $50 and $200 in some states.
Want Just A Single Layer Of Taxation? Try An S Corporation!
Unlike a C corporation, any distribution of income shareholders make is taxed once at an individual level. This is different from a C corporation where the corporation and distributions to shareholders are taxed. Of course, there are other advantages to changing your small business to an S corporation. The losses made from an S corporation are passed through to shareholders, which can be used to offset income. And just like an LLC, S corporations offer limited liability protections.
As with the other entities, S corporations do come with some limitations. If having a lot of shareholders is something you’re thinking about to raise capital, then an S corporation might hinder that ability. Under an S corporation, you can have no more than 100 shareholders. And in regard to shareholders, they must be individuals (though this comes with some exceptions) and be U.S. citizens or residents. A small business looking to change into an S corporation must also not have different classes of stocks.
When choosing what entity to switch over to, be sure to take into consideration any future goals and plans you wish to accomplish. Also, be mindful of the resources you have currently and what will be important to you later down the line. Each entity can bring something to the table, so it’s important to do as much research as you can before you go ahead and switch.