What Is the Best Entity to Run My Business?

By Chris J. Roe, CPA, PFS

Creating a new business is exciting. Yet, knowing which legal business entity to operate under can be difficult since there are several options, each with its benefits and concerns. [1]

When choosing a business entity, you must consider the legal aspects, such as asset protection, who owns the entity, and how it will be taxed. Moreover, consideration needs to be given to the amount of annual administration needed to maintain the business entity. For example, corporations need to hold annual meetings and maintain minutes, or else there is a possibility that if sued, the liability protection afforded by the corporate structure may be lost.

It is extremely important in operating a business entity to respect the formalities. Many business owners operate the business like their personal piggy bank, which could bring about unwanted legal and tax issues.

There is always a need to save money during the initial setup of starting a business, but you shouldn’t skimp on forming the business entity. You should always consult a qualified attorney and a CPA before making any decisions on the business structure. Do your research and understand the pros and cons of each business entity and how it protects your personal assets.

While not a replacement for professional advice, this overview of the common business entities can help you choose the right one for your situation.

Sole Proprietorship

Sole proprietorships are businesses owned by just one person and easily established. A sole proprietorship provides no personal asset protection to the business owner.

Forming and maintaining a sole proprietorship is easy, and no separate income tax return is needed. The business income must be reported on the Schedule C of the owner’s income tax return. [2]

With no protection between personal and business assets, owners become personally liable for their business’s financial obligations. However, it is recommended the business owner maintain a separate checking account for the business and keep appropriate accounting records.

This entity is generally best suited for businesses such as consulting, retail, freelance work, or other services provided directly by the owner and with no employees other than the owner. Since the owner is the sole employee and provides all services, other business entities may offer little asset protection.

Partnership

These are business entities owned by at least two people. Partnerships are not taxed at the partnership level but pass through their taxable income and losses to each partner based on their ownership percentage. The partners report the income or loss on their personal income tax return. [3]

If you are a general partner in a partnership, you will have exposure to the partnership’s liabilities. However, if you serve as a limited partner, your liability is generally limited to the money invested.

As for business control, general partners usually run the business. The operations are defined by a partnership agreement. As a limited partner, you have by definition, a “limited” say in the business operations.

Additionally, partnerships cost more to form than sole proprietorships due to the fact an attorney will need to draft the partnership agreement.

Finally, smaller groups of similar or complementary professionals, such as medical professionals, lawyers, and CPAs, generally operate as a partnership since they are looking to market their services under a single name and share business operations and control.

Limited Liability Company (LLC)

An LLC is treated as a separate legal entity that is distinct from its owners. It provides a layer of asset protection for the owner’s personal assets. However, an LLC provides great flexibility on how it is taxed. Depending on the number of owners, it may be taxed as a sole proprietor, partnership, corporation, or S-Corporation. LLCs can provide great flexibility. [4]

There is a default tax treatment for an LLC based on the number of owners and whether it is foreign or domestic. However, owners may elect to be treated differently for tax purposes under certain circumstances. [4]

Also, certain states, such as Wyoming, Nevada, and Delaware, provide better laws for forming and operating an LLC. However, when forming an out-of-state LLC, there are additional costs.

Businesses and their owners looking for the protection and separation of personal assets from the business while gaining ultimate flexibility with the corporate formalities may consider forming an LLC.

C-Corporation

A C-Corporation, also commonly known as a C-Corp, operates as its own distinct entity and offers personal liability protection to its shareholders. However, C-Corps also require more annual administration, such as meetings and recording of meeting minutes. Moreover, the corporation files its own income tax return and pays its own taxes on profits. Additionally, it may pay a higher corporate income tax rate than an individual shareholder might pay if the income were taxed on their personal tax return.

Full personal protection, the ability to generate funds through the sale of stocks, and potential tax advantages give C-Corps the support to operate for years to come. Additionally, the Federal tax code provides for gain exclusion in certain circumstances on the sale of corporate stock. [5]

The inherent disadvantage to operating a C-Corp is double taxation. C-Corps are taxed on their profits, and shareholders are taxed when they receive their dividends. This can result in a Federal tax as high as 39.8%.

With the introduction of the Qualified Business Income Deduction on pass-through entities, operating as a C-Corp may just be too costly. [6]

On the other hand, for businesses that will earn little money in the start-up phase but provide a large gain on a future sale, C-Corps may be a good operating structure.

S-Corporation

S-Corporations, also commonly known as an S-Corp, provide the same personal liability protection as a C-Corp while eliminating double taxation. However, S-Corps have their own restrictions on who can be a shareholder. [7]

S-Corps cannot tap into some of the tax advantages of a C-Corp and are required to have no more than 100 shareholders, all of whom must be U.S. citizens. [1]

Businesses and owners may gain advantages from the C-Corp structure while avoiding double taxation. Additionally, business owners who meet certain requirements may qualify for the Qualified Business Income Deduction, thus lowering the effective Federal income tax rate on taxable income. [6]

Consult a Tax or Legal Professional

Keep this information in mind as you go through the process of establishing your business entity, but remember that this is only a general overview and should not replace professional, personalized advice and recommendations you may receive when collaborating with a lawyer or CPA. Make sure to consult an expert and do not be penny wise, pound foolish when starting a new venture.

If you are considering starting a new business and need a complimentary consultation, please reach out to Rx Wealth.

Sources:

This content is developed from sources believed to be providing accurate information, and provided by Rx Wealth Advisors, in conjunction with Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.

Rx Wealth Advisors is a physician-focused financial advisory firm. Their primary focus is to help medical doctors maximize their earnings, keep more money in their pocket, and cultivate wealth so they can live the life they’ve earned and deserve. Rx Wealth can be reached at 412-227-9007, via email at croe@rxwealthadvisors.com, or on the web at rxwealthadvisors.com.