Choosing the Right Entity Type For Your Business

Starting a business and confused as to what type of entity you should use?

There are pros and cons to the different entities and what may be right for one business may not be right for the next.

Understanding the differences between entity types will help you as you make the decision for your business.

There are pros and cons to each entity type.

As a sole proprietor, this is the simplest entity type.  You file one form called Schedule C as part of your personal tax return.  The drawbacks are no legal separation and the full amount of your net income is subject to self-employment tax of 15.3%.  

LLC is another type.  People often misunderstand that an LLC is going to save money on taxes.  This is not the case.  A single member LLC is filed as a Schedule C on your personal tax return just like a sole proprietor.  You are still subject to self-employment tax.  If you have more than one member, you will elect to file as a partnership or as an S Corp.  However, the earnings are still subject to self-employment tax.  The pro to an LLC is the legal separation between your business and personal assets.  You are creating a separate entity.

A Corporation is another entity type that is separate from the individual.  A C Corp pays tax on the business profits and the owner will pay tax again at the personal level on compensation paid from the business.  There are times that this is the best type of set up.

There is also an S Corporation (small corporation) where you have less than 100 shareholders, you can't go public.  This does require extra paperwork in the form of an S Corp tax return, payroll tax returns, you need to hold annual meetings and document the minutes, etc.  But this does allow you to pay yourself a salary and treat part of the payment to you as a distribution, which can reduce self-employment tax.  This also creates the legal separation between personal and business.

My personal entity type of choice for most online business owners is to form an LLC and elect to have it treated as a S Corp for tax purposes.  This allows you to pay yourself a reasonable salary and take part of the earnings as distributions which helps to eliminate a portion of the self-employment tax.  This entity type is not for everyone though.  You will have extra expenses of filing a corporate return and quarterly payroll tax returns.  Have your accountant help you determine if the tax savings will more than make up for the extra expenses you will incur.

With all entity types it is important for you to treat your business like a business and keep personal and business expenses separate.

You can download this FREE resource by clicking the yellow button below