Updated August 12, 2020:

A business entity owner is one or more people who establish an organization — a business entity — that carries on a trade or business venture. There are several main types of business entities with different legal and tax implications, and deciding on a business entity requires close scrutiny.

Sole Proprietorships

A sole proprietorship (SP) has a single owner who runs the business for his or her personal profit. It is the type of business entity most used for beginning businesses. The business and its expenses are linked with the business owner, and the taxes of the business are reported on the owner's personal income tax return. The income tax forms for a sole proprietorship include:

  • Income tax forms for individuals.
  • Self-employment tax forms.
  • Estimated tax forms.
  • Social security, Medicare, and withholding tax forms.
  • Federal unemployment tax forms.

General Partnerships

A general partnership has more than one business entity owner. Each of the partners contributes some combination of money, property, labor, and skills to the company. They also all share in the business' profits and losses.

One benefit of a partnership is that lenders can be approached through the partnership rather than through individual partners. General partnerships do not pay taxes on the business. However, the partners usually own all of the company's assets, and they may ultimately be considered personally responsible for the company debts.

Corporations

A corporation is a business entity that is legally separate from the business owners and their finances. The activities of a corporation are regulated by its charter, by-laws, and a board of directors who are required to hold formal organizational meetings. When a business entity is incorporated, there are a number of steps to take to incorporate a business.

The corporate entity owns its own assets and has liability for its own debts. The stock shareholders are considered the legal owners of the company. However, they are not held responsible for the corporation's debts and taxes.

C Corporations

The main type of corporate entity is a C corporation. Its earnings can be taxed once when earned at the corporate level and again when distributed to shareholders. This double taxation can be minimized, however, if the entity pays out most or all of its earnings as salaries or rent.

Personal Service Corporations

A personal service corporation (PSC) is a C corporation established to provide professional services such as medical or legal work. PSCs are useful in limiting the owners' liability for debts accrued by the business while still maintaining the business owners' malpractice liability. Of the major business entity types, C and S corporations have the most involved requirements for owners.

S Corporations

An S corporation is created by filing an S corporation election with the Internal Revenue Service. This entity type comes with particular specifications such as having 100 or fewer shareholders and as being limited to distributing one type of stock. Eligible shareholders are also limited. The S corporation is not taxed on its earnings. The S corporation is permitted to compensate its owners through a salary that can be included in the owners' tax returns. the salary can then be deducted by the company as well.

Limited Liability Companies

A limited liability company (LLC) is a hybrid version of a partnership and a corporation that has limited liability exposure. The LCC business owner entity can choose to be taxed as a corporation, partnership, or a single-member LLC. For each of these types of taxation, the owner of the LCC will be charged similarly to the business entity type it chooses. LLCs are created under state law by registering according to the LLC statutes of the company's home state. The LLC entity owners' liability is limited to their financial investment in the company, and they are not held personally liable for the company's financial obligations.

Understanding the framework of business entities and how they fit in with national and state laws as well as tax laws are useful for making a decision about entity selection. For the sake of saving time and money, business entity owners and potential business entity owners must be sure to do their due diligence on the form their company should take.

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