<img height="1" width="1" style="display:none;" alt="" src="https://px.ads.linkedin.com/collect/?pid=938154&amp;fmt=gif">

Business Entity Types - Which is Best for Your Business?



A common question for those starting a business is “Which entity should I use for my business?”

There are many factors that go into deciding which business entity to choose. Whether you are starting a new business or are an existing business that is looking to change to a different entity, the information below can help you narrow down your choice.

In either case, it is important to consult with a professional who can provide guidance as to which entity would be the best fit for your company.

Types of Business Entities

Sole Proprietorship

Regarded as the simplest form of business entity, the owner is held personally responsible for all aspects of the business.

Advantages: Simplicity and low cost.

Disadvantages: The owner is personally liable for all business debts and obligations and may find it difficult to raise capital or attract investors.

Tax Benefits:

Simplified Tax Filing

The business owner can file a single tax return, which can be easier and less expensive than filing separate tax returns for the business and the owner.

Self-Employment Tax Deduction

A sole proprietor can deduct half of their self-employment tax (which includes Social Security and Medicare taxes) on their personal tax return.

Deductible Business Expenses

The business owner can deduct all "ordinary and necessary" business expenses from their taxable income, reducing their overall tax burden.

Home Office Deduction

If the business owner operates the business from a home office, they may be able to deduct a portion of their home expenses, such as rent or mortgage interest, utilities, and maintenance.

Start-Up Cost Deduction

The business owner may be able to deduct certain start-up costs (such as legal and accounting fees) within the first year of starting the business.

The tax benefits of a sole proprietorship may vary depending on the specific circumstances of the business owner.

Partnership

Similar to a sole proprietorship, but with two or more owners sharing the responsibility for the business. Partnerships can be general or limited, with general partners being personally liable for all business debts and obligations and limited partners having limited liability.

Advantages: Relatively easy to set up and operate.

Disadvantages: Can be complicated by disagreements between partners.

Tax Benefits:

Pass-Through Taxation

The partnership itself does not pay income tax. This can be beneficial because it avoids double taxation, which occurs when a corporation pays income tax on its profits and then its shareholders pay personal income tax on the dividends they receive.

Self-Employment Tax Savings

Partners in a partnership are generally not considered employees and therefore are not subject to payroll taxes (i.e., Social Security and Medicare taxes) on their share of partnership income.

However, partners are subject to self-employment tax on their share of partnership income, but the amount subject to self-employment tax is generally lower than if the partnership was structured as an S corporation or a C corporation.

Flexibility in Allocation of Profits and Losses

Partnerships have more flexibility than corporations in allocating profits and losses among partners. This can be advantageous in situations where partners have different financial needs or where one partner is more actively involved in the business than the other.

Deduction of Start-Up Expenses

Partnerships can deduct up to $5,000 of start-up expenses and an additional $5,000 of organizational expenses in the first year of operation. Any remaining start-up or organizational expenses can be amortized over a 180-month period.

The tax benefits of a partnership depend on several factors including the size and structure of the partnership, the specific tax laws, and regulations in the jurisdiction where the partnership operates, as well as the individual tax situation of each partner.

Limited Liability Company (LLC)

This is a hybrid business entity that combines the liability protection of a corporation with the tax benefits of a partnership. LLC owners, known as members, are not personally liable for business debts and obligations, and the company’s income is taxed as personal income for the members.

Advantages: Flexible and easy to set up.

Disadvantages: Can be subject to more regulations and fees than other entity types.

Tax Benefits:

Pass-Through Taxation

LLCs are typically treated as pass-through entities for tax purposes. This means that the profits and losses of the LLC are reported on the personal tax returns of the individual owners, rather than being subject to corporate taxes.

Self-Employment Tax Savings

Unlike owners of a corporation, LLC owners do not have to pay self-employment tax on the entire net income of the business. Instead, they only pay self-employment tax on their individual share of the profits.

Deductible Expenses

LLC owners can deduct a wide variety of business-related expenses from their taxable income such as salaries paid to employees, rent, utilities, and office supplies.

Flexibility in Profit Distribution

LLCs offer flexibility in how profits are distributed among owners. This can help owners minimize their tax liability by allocating profits to owners with lower tax rates.

Reduced Audit Risk

LLCs are less likely to be audited by the IRS compared to C corporations, which can save business owners time and money in the long run.

The tax benefits of an LLC can vary depending on factors such as the number of owners, the state in which the business is registered, and the specific tax laws in that state.

Corporation

A corporation is a separate legal entity from its owners, with shareholders owning the company and a board of directors overseeing its operations.

Advantages: Offers the most liability protection for owners; can issue stock to raise capital.

Disadvantages: Subject to more regulations and taxes than other entity types; may be subject to double taxation on their profits.

Tax Benefits:

Limited Liability Protection

Corporations provide limited liability protection for shareholders, which means that the personal assets of shareholders are typically not at risk in the event of lawsuits or debt obligations.

Lower Tax Rates

Corporations enjoy lower tax rates than individuals and are taxed as a separate legal entity. Depending on the size of the corporation, the tax rate can be as low as 21%.

Tax-Deductible Expenses

Corporations can deduct a wide range of expenses from their taxable income including employee salaries, benefits, rent, and other business-related expenses.

Retirement Plans

Corporations can offer their employees a range of retirement plans, such as 401(k) plans, which provide tax benefits for both the employee and the corporation.

Income Splitting

Corporations can distribute income among shareholders, allowing them to potentially reduce their tax liability by shifting income to shareholders in lower tax brackets.

The tax benefits of a corporation depend on a number of factors including the size of the corporation, its industry, and the location of its operations.

Cooperative

A cooperative is a type of business owned and controlled by its members, who share in the company’s profits and decision-making. Cooperatives can take many forms such as agricultural cooperatives or credit unions.

Advantages: Can be democratically run and controlled by its members; can be treated as a tax-exempt organization under certain circumstances.

Disadvantages: May be more difficult to raise capital or attract outside investors.

Tax Benefits:

Tax-Exempt Status

Cooperatives may be eligible for federal and state tax-exempt status, which means that they are not required to pay federal income tax on their earnings.

Pass-Through Taxation

Cooperatives are generally taxed as pass-through entities, which means that the business itself does not pay income tax. Instead, the profits and losses are passed through to the members, who report the income on their individual tax returns.

Deductible Expenses

Cooperatives are allowed to deduct certain expenses from their income such as wages, salaries, rent, and utilities. This can reduce the taxable income of the cooperative and the tax liability of the members.

Patronage Dividends

Cooperatives can distribute profits to their members in the form of patronage dividends, which are not subject to income tax at the cooperative level. Instead, they are taxed as income for the individual members.

Retained Earnings

Cooperatives can retain earnings in a reserve fund, which is not subject to income tax. This can help the cooperative build financial stability and invest in future growth.

Choose Wisely

The information above is simply an overview of the different business entity types. Talk with your accountant or financial professional to learn more about each entity and work with them to determine the entity that will provide your company with the most benefits.

Request More Information

© 2023 SVA Certified Public Accountants

Share this post:


Biz Tip Topic Expert: Molly Taylor - CPA, MT

Molly Taylor - CPA, MT

Molly is a Manager with SVA and specializes in individual and corporate taxation with an emphasis on federal and multistate tax issues. In addition to tax preparation services, she works closely with clients throughout the year advising on tax planning opportunities and strategies.

Awards and Affiliations

milwaukee-business-journal-largest-milwaukee-area-accounting-firms-2022-logo2
sva-certified-public-accountant-affiliation-wicpa
SVA_2023_Certification_Badge-white
accountingtoday-white
sva-award-logo-inside-public-accounting-top-200-firms-2023
sva-certified-public-accountant-affiliation-m-power-business-champion-program
sva-certified-public-accountant-affiliation-aicap-ebpaqc-member
2023ECA_Finalist-white
sva-certified-public-accountant-affiliation-aicpa

Locations

Madison, WI
1221 John Q Hammons Dr, Suite 100
Madison, WI 53717
(608) 831-8181

Milwaukee, WI
18650 W. Corporate Drive, Suite 200
Brookfield, WI 53045
(262) 641-6888

Colorado Springs, CO
1880 Office Club Pointe, Suite 128
Colorado Springs, CO 80920
(719) 413-5551

SVA BBB Business Review Man Standing

Contact

(888) 574-4782
info@SVAaccountants.com
BizTips

Are you in the know on the latest business trends, tips, strategies, and tax implications? SVA’s Biz Tips are quick reads on timely information sent to you as soon as they are published.

Connect With Us

Copyright © 2024 SVA Certified Public Accountants | Privacy Policy | Cookie Policy | CCPA