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What is a Business Entity?
A business entity is an organization founded by one or more individuals to conduct a specific business or allow them to engage in a trade or similar activities. Business entities, also referred to as business structures, are formed at the state level by filing documents with a state agency like the Secretary of State.
The four major business entity types include sole proprietorship, partnership, limited liability company (LLC), and corporation. The entities are expected to comply with the state laws by filing specific documents and paying any obligatory fees to set up the business legally.
Your choice of business entity will determine the organization's structure and, in turn, the documents you will need to file, your ability to raise money, how liability is determined and how taxes are paid. The type of business you wish to engage in and the number of owners will highly determine the type of business entity you choose.
Four Types of Business Entities
There are many types of business entities recognized by the state. However, these four are the major ones that business owners choose from.
1. Sole Proprietorship
A sole proprietorship is undoubtedly the easiest business entity to set up and operate. When you launch a business and are the sole owner or the operator, you are a sole proprietor under the law. This entity doesn't require registration with the state, but you might be required to apply for local business permits and licenses, depending on your industry.
Example: Service professionals like consultants and freelancers are often sole proprietors. Established businesses like retail stores with one person at the helm can also be sole proprietorships.
Pros for Sole Proprietorships:
- The business is easy to start as you don’t need any state registration.
- Corporate formalities and paperwork requirements are not necessary when setting up.
- With this type of structure, tax filing is easy. You don't separate your tax as either business or personal; you only file one tax.
- You can deduct most of your business losses from your personal tax return.
Cons for Sole Proprietorships:
- You are personally liable for all business debts, which can put your personal assets at risk should your business be sued. (No limited liability protection).
- It isn't easy to secure a business loan and raise money. Lenders and investors tend to prefer corporations and LLCs.
- Building business credit and getting a business loan with an unregistered business entity is hard.
2. Partnership
A partnership is an unincorporated business entity formed by two or more individuals. All partners agree to manage the business and share profits and losses. Partnerships come in two forms: general partnerships (GPs) and limited partnerships (LPs).
General Partnerships
A general partnership resembles a sole proprietorship closely, but for the fact that these have two or more owners. The business may not need to register depending on the state, but might need to pay for business licenses and permits depending on their industry. In most states, a general partnership is formed by signing a partnership agreement by all members.
- The business entity is easy to start and dissolve as you don’t need any state registration.
- Owners can deduct most of their business losses from their personal tax returns.
- Corporate formalities and paperwork requirements are not necessary when setting up.
- All owners share in any profits and losses from the business.
- Having several partners share in the start-up struggles can be very helpful.
Read more about the advantages of a partnership.
Disadvantages of a partnership:
- Each one of the owners is personally liable for business debts and liabilities.
- Building business credit and getting a business loan with an unregistered business entity is hard.
- In some states, all partners are personally liable for each other's negligent actions ( joint and several liability ).
- Each partner has independent power to loans and contracts binding the business.
- Disputes amongst the owners/partners can derail the business.
- Partnership dissolves automatically if a partner dies.
Limited Partnership
A limited partnership (LP) is a form of a registered business entity. Of the partners, only one partner has complete responsibility and general liability for the business. The others only provide money and don't actively manage the business.
The LP files returns that report the business’ income, gains, losses, and deductions. However, they don't file income tax. Profits and losses made by the LP business are passed to the business partners, with the silent partners only sharing in the profits and not the losses or liability.
Pros of a limited partnership:
- A good option for raising money as investors can join the partnership without personal liability.
- The general partner still maintains control over their business even after getting funding from limited partners.
- Limited partners can withdraw from the partnership without dissolving the business.
Cons of a limited partnership:
- General partners solely bear all business debts and liabilities.
- Setting up an LP business requires a state filing, making it more expensive to set up than a GP.
- Any limited partner of an LP who takes an active role in business risks facing personal liability.
Examples: Red Bull & GoPro, Apple & MasterCard, Airbnb & Flipboard.
Other forms of partnerships operate as legal entities fully registered with the state and with limited liability protection shielding the partners' assets. The debate on general partner vs. limited partner centers on personal responsibility and liability for business losses and liabilities. These partnerships also include the limited liability partnership (LLP) and limited liability limited partnership (LLLP).
Here is an article that explores more about partnerships.
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3. Limited Liability Company (LLC)
A limited liability company take the positive features of other businesses with liability protection. The owners of a limited liability company are only responsible for its debts up to the extent of their invested capital. That is to say, the structure of an LLC protects its owners from any personal responsibility for liabilities and debts incurred by the LLC.
Legally, a limited liability company is an entity separate from its owners. It can be owned by one individual (including another business) or many people ( multi-member LLC ), making it a valuable alternative for individual business owners. All LLCs should have a business plan and an LLC operating agreement that sets out the financial details and working relations between the owners and the managers.
Examples: Pepsi-Cola, Blackberry, Nike.
Pros of a limited liability company:
- LLC owners have no personal liability for the business's liabilities and debts.
- You have the option to choose if your LLC gets taxed as a corporation or partnership to avoid double taxation.
- LLC has fewer corporate formalities than B corp, C corp, and S corp.
- LLC have no ownership restrictions; owners can range from 1 number to whichever maximum.
- Active members of an LLC can deduct operating any operating losses against a member’s regular income
Cons of a limited liability company:
- An LLC with partners who are also employees with fringe benefits like medical insurance, parking, and group insurance must treat them as taxable income
- Profits from an LLC are subject to Medicare and social security taxes, meaning the owners might end up paying more taxes compared to owners of a corporation.
- LLC’s require registration with the state to conduct business, making them more expensive to create than partnerships or sole proprietorships.
LLCs must also have articles of organization, which is basically a founders’ agreement or internal regulations that bind and guide the operations and interactions. You will also need to agree on having a member-managed LLC vs. a manager-managed LLC.
Here is an article with more on LLCs.
4. Corporation
A corporation is a popular type of legal business entity where owners are protected by limited liability. Its charter restricts its name and scope of activities. A corporation, is a legal entity that can make a profit and be held legally liable. Stakeholders who are also employees can take advantage of certain tax-free benefits like health insurance.
Corporations cost more to set up compared to other business structures. They also require extensive operational processes, bookkeeping, reporting, and tax compliance. Corporations pay income tax on their profits and depending on the type of corporation, may at times taxed twice - from the profits and dividends. They are a good choice for businesses with medium to high risk.
There are two main types of corporations: C corporations and S corporations. C corporations have their income taxed separately from their shareholders, and therefore face double taxation. S corporations instead have their income taxed directly as part of their shareholders’ income, although they are subject to additional restrictions on their ownership. Some states tax S corporations separately in the same way as C corporations, but most states and the federal government give them this pass-through tax status.
Examples: Microsoft, Apple Inc., Walmart Inc. are all corporations.
Pros of a corporation:
- Owners/ shareholders have no personal liability to liabilities and debts of the business.
- Corporations can raise money by offering stock.
- C corporations are subject to more tax deductions than other business structures, with their owners paying lower self-employment taxes.
Cons of a corporation:
- C corporations are more expensive to create compared to partnerships and sole proprietorships.
- They face double taxation by taking corporate tax returns and still having shareholders pay taxes on their dividends.
- Has too many formalities like holding shareholder and board meetings, creating bylaws, and keeping minutes of all meetings.
Other types of corporations like S corp and B corp, also governed by corporate bylaws. When setting up, there must first be a shareholders' agreement.
There is more on Corporations in this article.
How to Create a Business Entity
- Sole proprietorship: Write a business plan, obtain a DBA certificate if operating under a name that isn’t your own, and you are set to start operating.
- Partnership: Operates more or less like a sole proprietorship, so follow the process above. The only extra document is a partnership agreement.
- LLC: Write a business plan, file documents with the state, create an operating agreement, operate your business.
- Corporation: Choose the business name, determine the initial directors, file documents with the state, draft corporate bylaws and adopt them in a board meeting, issue shares.
Get Help with Forming a Business Entity
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Meet some of our Business Entity Lawyers
Taren C.
The Castro Law Firm, located in Royal Palm Beach, Florida, provides a range of legal services to clients that focus on probate, estate plannnig and business matters. Our staff is fluent in Spanish. We offer free consultations and virtual appointments.
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I build legal solutions which create extraordinary value for my clients. I am a partner in Alliance Law Firm International PLLC in Washington. My specialties include tax, wealth management, estates, corporations/business, venture capital, private equity, and natural resources. Prior to practicing law, I had a decade-long career in international private equity and investment banking. I have worked on building and managing companies in technology, energy, materials, retail, and natural resources. I am licensed to practice in the District of Columbia and Pennsylvania. I have degrees from the Georgetown University Law Center (JD) and the Yale School of Management (MBA).
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I am Muhammad, a legal counsel, technology law advisor, and corporate and commercial law expert, licensed to practice in New York State. I graduated from University of London and Georgetown Law Center and have about 5 years of experience in corporate and commercial law. As a As a technology law advisor, I possess deep insights into SaaS agreements, master service agreements, master subscription agreements, and SaaS Agreements, among others.
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Alexandra I.
I am a licensed attorney in California specializing in consumer contract law. My areas of expertise include contract law and employment law, including independent contractor compliance, work-for-hire compliance and general corporate law. I appreciate getting to know my clients and enjoy providing legal guidance, whether they are large corporations, young start-ups about to take off, or just one person in need of legal advice. Some of my recent work has included the drafting of corporate purchase and sale agreements, independent contractor agreements, nondisclosure agreements, and software as a service (SaaS) agreements. I am well-versed in intellectual property law and have successfully obtained trademarks for former clients. My passion for learning, reading and writing has proved advantageous in my practice. I complete continuing education courses to stay current on industry best practices. I take great satisfaction in offering precise and helpful legal advice free from fancy terminology. I look forward to discussing your particular needs and supporting you in achieving your objectives. Please get in touch to learn more about my approach and see whether we are a good fit.
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I'm Jennifer Gunnell, a seasoned legal professional with a J.D. from the University of California, Los Angeles School of Law. I have extensive experience in litigation, family law, and public service work. My career began at Schonburn Seplow Harris & Hoffman in Los Angeles, focusing on civil litigation in environmental and civil rights issues. I then joined the American Civil Liberties Union of Washington as a Staff Attorney, where I authored policy documents, coordinated civil litigation, and engaged with stakeholders on civil rights issues. Subsequently, I managed legal representation for low-income survivors of domestic violence at Snohomish County Legal Services, addressing county and state issues related to domestic violence and sexual assault. As an Assistant Attorney General at the Attorney General's Office of Washington, I led multiple jury trials, directed trial teams, and reported on legal and legislative changes. My international experience includes a role at the United Nations Office of the High Commissioner for Human Rights in Geneva, where I provided support to the Special Rapporteur for the Independence of Judges and Lawyers. I'm a member of the State Bar of California (2016, now retired) and the State Bar of Washington (2018, active). Beyond my professional endeavors, I've volunteered as an Attorney General Legal Hotline Volunteer, Domestic Violence Clinic Volunteer, Northwest Immigrant Rights Project Volunteer, and Seattle Animal Shelter Volunteer and Dog Foster. With a comprehensive legal background and a tenacious attitude, I bring dedication and expertise to every role.
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Business Entity
Arizona
I wonder if it would be beneficial and/or necessary for me to becoming an LLC?
I am a part time face painter in Arizona. I have about 10-20 events a year. I estimate that I will make 3-5K per year.
Jane C.
I suggest you consult with an experienced business attorney.
Business
Business Entity
Tennessee
What are memphis llc fees
Was buy home but he past and son put his name on a quick clam deed. What can I do need help
Jane C.
The Tennessee Secretary of State website has a business division with business start up guides. I suggest you review that website https://sos.tn.gov/businesses.
Small Business
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Illinois
I have an LLC for rental investment. Can i use the LLC to do independent corp to corp work.
Currently employed, with investment property under LLC. Would like to do independent contract work.
T. Phillip B.
The question isn't whether you can do it, but is whether you SHOULD do it. You definitely would be able to do other work within the LLC. However, in doing so, now you active work and passive income are getting combined which would likely subject your passive income to the 15.3% self employment tax. Let me know if you have any questions on how to structure the businesses.
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Business Entity
Illinois
How much does an Operating Agreement and Ownership Certificate cost
I’m forming a Nonprofit LLC
Mathew K.
It depends on your circumstances. For example, single member LLC's are simpler and more affordable. Try posting your question as a proposal at this link so attorneys can bid on it: https://www.contractscounsel.com/client/create-project/step-h1?cta=4.
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