There are many steps to starting a business, but choosing a business entity is one of the most important ones. The legal and tax consequences of your business depend on the type of business you choose.
There are also different protections from liability and ways to keep an owner’s personal assets separate from their business assets. Here are some of the most common types of business entities that people use when they start a new business.
Sole Proprietorship
A business run by one person is called a “sole proprietorship.” Setting up a sole proprietorship is easy because you don’t have to fill out much paperwork to get started.
You just start the business in your name, and all of the money the business owes comes from your personal accounts. But this choice is also the most dangerous. When a person owns a business as a sole proprietor, he or she is personally responsible for all business finances.
DBA
“Doing business as” is what “DBA” stands for. It’s not really a business, but rather an application that gives your business a different name. If you are a sole proprietor and file for a DBA, you can give your business a name other than your own and stop using your own name.
This gives your business more credibility and gives you a little more privacy. A DBA, on the other hand, is not a legal name. When you change your DBA, your business doesn’t change.
Partnership or Limited Partnership
The next step up from a sole proprietorship is a general partnership or a limited partnership. In a general partnership, you, as the person who started the business, would bring on a partner to share the debts of the business.
In a limited partnership, each limited partner’s personal liability is limited to the amount of money they have put into the business.
The business’s tax return is kept separate from the partners’ personal tax returns. Profits and losses must be reported on a regular basis.
“These kinds of structures aren’t too expensive to set up, and any business losses can be put toward the partner’s tax bill,” ZenBusiness wrote.
“Most partnerships fail because of the people involved. Since you and your partner are both responsible for the business, if your partner goes bankrupt, the bill will fall on you.
LLC
An LLC, or limited liability company, is a business structure that lets partners or owners limit their personal liability while keeping the tax flexibility of a partnership. A LLC must be registered with the state (meaning there will be a filing fee).
When you run an LLC, you have to pay federal, state, and local taxes. This means that you have to pay more in taxes. But LLCs keep the owners from being held personally responsible.
“An LLC makes sense if your company is only at the point in its development where you can attract angel investors but not venture capitalists,” wrote Early Growth Financial Services.
This means that you expect your business to lose money. “The potential tax losses will motivate angel investors, but not venture capitalists. Investors still like to buy stock in a company more than membership interests.”
Corporation
Lastly, some entrepreneurs decide to start a C corporation, a S corporation, or a nonprofit corporation right from the start. This type of business entity is completely separate from its owners and has its own legal rights.
This means that a corporation can sue, own and sell property, and sell ownership in the form of equities. The biggest benefit is, of course, that owners and shareholders don’t have any legal or financial responsibility for how the business is run.
Corporations have their own tax returns. Compliance is a big part of running a business, so this structure works best for bigger startups that can afford to hire an accountant. In the end, these kinds of businesses are more complicated than a sole proprietorship or a partnership, so they cost more.
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