Types of Business Entities

Read our Guide to Business Entity Types and discover which one provides the most legal and financial benefit for your Business!
Denise Elizabeth P
Senior Financial Editor & Contributor
Last Updated: April 26, 2021
Date Published: April 6, 2021

When starting a business, you will have to decide what form of business entity you are going to use.

What is a Business Entity?

In simple terms, a business entity is an organization that is formed by one or more persons to engage in business.

The type of business entity that you choose determines which income tax return form you have to file but more importantly, it determines how much tax you have to pay, and determines your risk exposure.

This decision will have important legal and financial implications for your business, so understanding each business entity type will help you determine which option is the right one for you and your organization.

Businesses are formed at the State level and State governments in the United States recognize around a dozen different business entity types.

Most small businesses choose between the top six business entity types as follows; Sole Proprietorship, General Partnership, Limited Partnership (LP), Limited Liability Company (LLC), C Corporation, or S Corporation.

In this Guide we are going to dive into each of the six popular business entities mentioned above so that you can decide on a structure for your company.

Types of Business Entities

As mentioned above, there are over a dozen types of business entities to choose from with the most common being Sole Proprietorship, General Partnership, Limited Partnership (LP), Limited Liability Company (LLC), C Corporation, or S Corporation.

Here is a list of the business entity types you can choose from in the U.S.:

BUSINESS ENTITY TYPEDESCRIPTION
Sole Proprietorship – also known as a sole trader, individual entrepreneurship or proprietorshipAn unincorporated business run by one person or jointly married couple and in which there is no legal distinction between the owner and the business entity.
General Partnership – GPAn unincorporated business run by two or more persons who agree to share in all assets, profits, and liabilities of a business.
Limited PartnershipAn unincorporated business run by at least two active general partners and at least one limited partner.
Limited Liability PartnershipType of partnership structure that offers liability protection for all partners.
Limited Liability Limited PartnershipType of partnership that offers some liability protection to the GP’s.
Limited Liability Company – LLCUnincorporated legal structure of a business that offers liability protection to all of its owners and members.
Professional Limited Liability Company – PLLCLLC structure professionals, such as accountants, doctors, etc.
C CorporationIncorporated legal structure that consists of shareholders, directors, and officers.
S CorporationIncorporated legal structure for businesses that offers pass-through taxation.
B CorporationCorporations that are for-profit and meet social and environmental standards.
Professional CorporationCorporate structure for professionals such as accountants, doctors, etc.
Nonprofit OrganizationCorporations that benefit the public and are do not earn a profit.
CooperativePrivate, member-owned association to meet their common economic, social, and cultural needs through a jointly-owned and democratically controlled enterprise.
MunicipalityA city or town that has a corporate status and local government.
EstateLegal entity created of the sum of a person’s assets – legal rights, interests and entitlements to property of any kind – less all liabilities at that time.

As you can see, there are a lot of business entity options but most entrepreneurs and business owners will choose the six common business entity types; Sole Proprietorship, General Partnership, Limited Partnership (LP), Limited Liability Company (LLC), C Corporation, or S Corporation.

Below, we have explained each of the six popular entity types in more detail, covering the pros and cons of each.

Six Most Common Business Entity Types:

Sole Proprietorship

Sole proprietorships are perhaps the most different and unique compared to corporations, limited liability companies (LLCs), partnerships, etc.

The biggest difference is that a sole proprietorship is not a separate legal entity.

The business owner and the sole proprietorship are essentially the same, thus making the owner responsible for any and all liabilities incurred by the business entity.

A sole proprietorship is an unincorporated business with only one owner who pays personal income tax on profits earned.

Why business owners choose a Sole Proprietorship:

  • The main benefit of a sole proprietorship is the pass-through tax advantage
  • Ease of creation, and the low fees of creation and maintenance.

The biggest disadvantage of a sole proprietorship is that the owner has unlimited liability.

Many entrepreneurs begin as a sole proprietorship because of how simple they are to setup and because filing taxes is pretty straightforward.

However, most sole proprietorships eventually end up getting restructured to an LLC as the company expands and grows.

Pros of Sole Proprietorship

  • Easy and inexpensive to form – A sole proprietorship is the simplest and least expensive business structure to establish. Costs are minimal, with legal costs limited to obtaining the necessary licenses or permits.
  • There is a lack of government involvement, making them popular with small business owners and contractors.
  • All profits/losses are passed through to the owner’s personal tax return and you are only responsible for paying personal federal, state, local and Federal Insurance Contributions Act (FICA) taxes. You are not required to pay any specific business taxes or unemployment taxes.
  • Complete control – Because you are the sole owner of the business, you have complete control over all decisions. You aren’t required to consult with anyone else when you need to make decisions or want to make changes.
  • Easy tax preparation – Your business is not taxed separately, so it’s easy to fulfill the tax reporting requirements for a sole proprietorship. The tax rates are also the lowest of the business structures.
  • You can still enjoy just about all of the same tax benefits of being self-employed, from turning some of your personal expenses into business expenses (business use of your home or car, for example), utilizing self-employed retirement plans like Simplified Employee Pension Individual Retirement Accounts for higher deductions, writing off regular business expenses such as marketing costs, writing off business travel costs, writing off costs to entertain clients and more.

Cons of Sole Proprietorship

  • Unlimited personal liability – Because there is no legal separation between you and your business, you can be held personally liable for the debts and obligations of the business. This risk extends to any liabilities incurred as a result of employee actions.
  • Funding challenges – Sole proprietors often face challenges when trying to raise money. You cannot sell stock in the business, which limits investor opportunity. Many financial institutions will characterize loans as “personal loans” rather than “business loans.” Banks are also hesitant to lend to a sole proprietorship because of a perceived additional risk when it comes to repayment if the business fails.
  • More on the line – The flip side of complete control is the burden and pressure it can impose. You alone are ultimately responsible for the successes and failures of your business. Hardships and failures not only affect your business, but your personal life since there is no legal separation between the two.

Sole Proprietorship Key Takeaways

Simple to set up and maintain – no annual meetings, formal officers, or complicated records.
As the sole owner of the business, you have complete control over all decisions. You aren’t required to consult with anyone else when you need to make decisions or want to make changes.
Easy tax preparation – Your business is not taxed separately, so it’s easy to fulfill the tax reporting requirements for a sole proprietorship. The tax rates are also the lowest of the business structures.
Unlimited personal liability – Because there is no legal separation between you and your business, you can be held personally liable for the debts and obligations of the business. This risk extends to any liabilities incurred as a result of employee actions.
Most sole proprietorships end up being restructured to an LLC or other business type.

 

General Partnership

Before we define a General Partnership, let’s first talk about what is required to even form one.

A general partnership must satisfy the following conditions:

  • The partnership must include two or more people.
  • All partners must agree to any liability that their partnership may incur.
  • The partnership should ideally be memorialized in a formal written partnership agreement, though oral agreements are valid.

If you already know that your business is going to only have one owner, then an LLC is going to be the business structure you will most likely choose.

If your business is going to have two or more owners, then keep reading to learn more about general partnerships.

A general partnership is a business arrangement by which two or more individuals agree to share in all assets, profits, and financial and legal liabilities of a jointly-owned business.

In a general partnership, partners agree to unlimited liability, meaning liabilities are not capped and can be paid through the seizure of an owner’s assets.

Furthermore, unlike an LLC, any partner may be sued for the business’s debts.

So if there seems to be so much liability with a general partnership, why do businesses choose it?

When individuals form partnerships, they are taxed just like a sole proprietorship.

Each partner must include their business income on their personal tax return and they can deduct business losses on their individual tax return as well.

This is called a “pass through” entity because the profits and tax obligations pass through the company to the partners where income is divided according to their agreement.

With general partnerships, each partner tends to have “more on the line” because they are more liable than an LLC.

Often times this leads to more involved managers who look out for the best interest of the company.

It also often requires a majority vote for major business decisions.

PROS of a General Partnership

  • Although you often operate under a partnership agreement, you are not required to file one with the state and no laws require one in writing.
  • Offer participants the flexibility to structure their businesses however they see fit, giving partners the ability to control operations more closely.
  • Less expensive to form compared to a Corporation or LLC and involve less paperwork
  • Pass-through taxation for all members – taxed just like a sole proprietorship.
  • Members have the option to take on limited partnership. Limited partnerships, as their names suggest, subject partners to less liability. In a limited partnership, there are one or more general partners and one or more limited partners, which spreads liability across everyone involved.

CONS of a General Partnership

  • Each owner is personally liable for the business’s debts and other liabilities.
  • In some states, each partner may be personally liable for another partner’s negligent actions or behavior (this is called joint and several liability).
  • Disputes among partners can unravel the business (though drafting a solid partnership agreement can help you avoid this).
  • It’s more difficult to get a business loan, land a big client, and build business credit without a registered business entity.
  • Members have the option to take on limited partnership. Limited partnerships, as their names suggest, subject partners to less liability. In a limited partnership, there are one or more general partners and one or more limited partners, which spreads liability across everyone involved.

General Partnership Key Takeaways

A Partnership is an unincorporated business run by two or more persons who agree to share in all assets, profits, and liabilities of a business.
Offer participants the flexibility to structure their businesses however they see fit, giving partners the ability to control operations more closely.
Pass-through taxation for all members – taxed just like a sole proprietorship.
Each owner is personally liable for the business’s debts and other liabilities.
Members have the option to take on limited partnership. Limited partnerships, as their names suggest, subject partners to less liability. In a limited partnership, there are one or more general partners and one or more limited partners, which spreads liability across everyone involved.

 

Limited Partnership

Unlike a general partnership, a limited partnership (LP) is a registered business entity.

To form a limited partnership, therefore, you must file paperwork with the state.

In an LP, there are two kinds of partners: those who own, operate, and assume liability for the business (general partners), and those who act only as investors (limited partners, sometimes called “silent partners”).

Limited partners don’t have control over business operations and have fewer liabilities.

They typically act as investors in the business and also pay fewer taxes because they have a more tangential role in the company.

PROS of Limited Partnership

  • An LP is a good option for raising money because investors can serve as limited partners without personal liability.
  • General partners get the money they need to operate but maintain authority over business operations.
  • Limited partners can leave anytime without dissolving the business partnership.

CONS of Limited Partnership

  • General partners are personally responsible for the business’s debts and liabilities.
  • More expensive to create than a general partnership and requires a state filing.
  • A limited partner may also face personal liability if they inadvertently take too active a role in the business.

C Corporation

A C-corporation is an independent legal entity that exists separately from the company’s owners.

Shareholders (the owners), a board of directors, and officers have control over the corporation, although one person in a C-corp can fulfill all of these roles, so it is possible to create a corporation where you’re in charge of everything.

This being said, with this type of business entity, there are many more regulations and tax laws that the company must comply with.

Methods for incorporating, fees, and required forms vary by state.

PROS of C Corporation

  • Owners (shareholders) don’t have personal liability for the business’s debts and liabilities.
  • C-corporations are eligible for more tax deductions than any other type of business.
  • C-corporation owners pay lower self-employment taxes.
  • No shareholders limit. However, once the company has $10 million in assets and 500 shareholders, it is required to register with the SEC under the Securities Exchange Act of 1934.
  • Enhanced credibility – gain respect among suppliers and lenders.
  • You have the ability to offer stock options, which can help you raise money in the future.
  • Unlimited growth potential thanks to the sale of stock.

CONS of C Corporation

  • More expensive to create than sole proprietorships and partnerships (the filing fees required to incorporate a business range from $100 to $500 based on which state you’re in).
  • Double taxation. It’s inevitable as revenue is taxed at the company level and again as shareholder dividends.
  • Owners cannot deduct business losses on their personal tax returns. Unlike an s corporation (s corp), shareholders can’t deduct losses on their personal tax returns.
  • There are a lot of formalities that corporations have to meet, such as holding board and shareholder meetings, keeping meeting minutes, and creating bylaws.

C – Corporation Key Takeaways

Owners (shareholders) don’t have personal liability for the business’s debts and liabilities.
C-corporations are eligible for more tax deductions than any other type of business.
You have the ability to offer stock options, which can help you raise money in the future.
Unlimited growth potential thanks to the sale of stock.
There are a lot of formalities that corporations have to meet, such as holding board and shareholder meetings, keeping meeting minutes, and creating bylaws.
Double taxation. It’s inevitable as revenue is taxed at the company level and again as shareholder dividends.

S Corporation

An S Corporation is similar and different to an LLC in a few key ways.

According to the Internal Revenue Service “S Corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.”

Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates rather than at a corporate tax rate.

However, there are certain qualifications that need to be met in order to be approved for an S corporation status:

  • Must be a domestic corporation
  • Allowable shareholders – individuals, certain trusts, and estates and may not be partnerships, corporations, or non-resident alien shareholders.
  • Cannot have more than 100 shareholders and only one class of stock
  • Certain business types such as financial institutions, insurance companies, and domestic international sales corporations are not eligible for an S corporation election.

PROS of an S Corporation

  • Liability protection – Much like an LLC, an S corporation provides liability protection for the personal assets of its shareholders. So long as there isn’t a personal guarantee, a shareholder does not have personal liability for the business debts and liabilities of the corporation.
  • Pass-through taxation – An S corporation does not pay federal taxes at the corporate level. Any business income or loss is “passed through” to shareholders who report it on their personal income tax returns. This means that business losses can offset other income on the shareholders’ tax returns to reduce income tax paid.
  • Tax-favorable characterization of income – Shareholders of an S corporation can draw “reasonable” salaries as employees of the business. They can also receive dividends from the corporation, as well as other distributions that are tax-free to the extent of their investment in the corporation.
  • Easy transfer of ownership – Interests in an S corporation can be freely transferred without triggering adverse tax consequences. The S corporation does not need to make adjustments to property basis or comply with complicated accounting rules when an ownership interest is transferred.
  • Easier accounting – Unlike Corporations, an S Corporation can use the cash method of accounting unless they have inventory.

CONS of an S Corporation

  • Expensive Formation and maintenance – S corporations are required to first incorporate the business by filing Articles of Incorporation with the desired state of incorporation, obtain a registered agent for the company, and pay the appropriate fees. Many states also require ongoing fees and annual reporting requirements as well as franchise tax fees.
  • Reporting errors and tax errors – In rare cases, mistakes regarding the various election, consent, notification, stock ownership and filing requirements can accidentally result in the termination of S corporation status.
  • Stock restrictions – S corporations can only have one class of stock and no more than 100 shareholders. Also, foreign ownership is prohibited completely.
  • Increased IRS scrutiny – Because amounts distributed to a shareholder can be dividends or salary, the IRS scrutinizes payments to make sure the characterization conforms to reality. As a result, wages may be re-characterized as dividends, costing the corporation a deduction for compensation paid. Conversely, dividends may be re-characterized as wages, which subjects the corporation to employment tax liability.
  • Less flexibility in allocating income and loss – Because of the one-class-of-stock restriction, an S corporation cannot easily allocate losses or income to specific shareholders. Allocation of income and loss is governed by stock ownership, unlike a partnership or LLC where the allocation can be set in the operating agreement. Also, the necessary accumulated adjustment account can be cumbersome to maintain, requiring input from an accounting professional.
  • Taxable fringe benefits – Most fringe benefits provided by the corporation are taxable as compensation to employee-shareholders who own more than 2 percent of the corporation.

S Corporation Key Takeaways

S-corporations, like partnerships, are pass-through entities.That is, there is no federal income tax imposed at the corporate level. Instead, an S-corporation’s profit is allocated to its shareholder(s) and taxed at the shareholder level (personally).
Distributions from the business are not taxable so long as they are not in excess of the shareholder’s basis in the S-corporation.
An S corporation usually does not pay federal taxes at the corporate level. As a result, an S corporation can help the owner save money on corporate taxes. The S corporation allows the owner to report the taxes on their personal tax return, similar to an LLC or sole proprietorship.
S corporations have more regulations and guidelines that must be followed
The IRS is more restrictive regarding ownership for S corporations than for LLCs.
Subject to higher IRS scrutiny.
Shareholders must receive a “reasonable” amount of compensation before they are exempt from paying self-employment tax on their share of an S-corp’s profits.

Limited Liability Company (LLC)

An LLC is a popular and safe option for most small business owners.

It provides a flexible business structure and is fairly simple to set up.

Why business owners choose an LLC:

  • Business owners are not liable for the company’s debts and can choose their own management structure.
  • They qualify for pass-through taxation – meaning that profits are only taxed once.

Each business structure has its own advantages and features but for the majority of small businesses, an LLC is going to be the best choice.

LLC’s are simple, flexible and protect your personal assets.

An LLC (limited liability corporation) is a business structure designed to protect business owners from being personally liable for the company’s debts or other liabilities.

Furthermore, LLC’s can be owned by more than one person known as LLC “members”.

If the business doesn’t do as well as planned or you have a rough year, you as the business owner are personally protected under an LLC.

For example, if your LLC declares bankruptcy or is sued, your personal assets such as your vehicle, personal bank accounts, and house are safe.

Single-member LLC’s are pass-through entities which means that profits and losses from the LLC are “passed through” to you and taxed as personal income.

This benefits you because you are not required to pay both corporate and personal taxes on your earnings.

Multi-member LLC’s are taxed as partnerships and are also pass-through entities.

This means each owner pays personal income taxes on their portion of the profit.

PROS of an LLC

  • No member limit- The owners or members of an LLC are free to choose whether the owners or designated managers run the business and how many member they want.
  • Personal asset protection – as mentioned above, your personal assets are protected should your LLC go bankrupt or be sued.
  • Pass-through taxation benefits – Limited liability companies are taxed differently from other corporations. An LLC allows pass-through taxation, which is when the business income or losses pass through the business and are instead recorded on the owner’s personal tax return. As a result, the profits are taxed at the owner’s personal tax rate. A single-member LLC is typically taxed as a sole proprietorship. Any profits, losses, or deductions, which are business expenses that reduce taxable-income, are all reported on the owner’s personal tax return. An LLC with multiple owners would be taxed as a partnership, meaning each owner would report profit and losses on their personal tax return.
  • Simple to set up and maintain – no annual meetings, formal officers, or complicated records.
  • Flexible – LLC’s have very little restrictions regarding the company’s structure. You decide if you want your business to be a single member LLC, multi-member LLC, and so on.
  • LLC’s are a widely recognized business structure and bring credibility to your organization.
  • Access to financing – Once your LLC is formed, you can start to build a credit history which opens the door to business loans and financing to grow your business.
  • Flexible profit sharing – LLC’s can choose how they want to do their profit sharing, they are not required to be equally distributed among members.

CONS of an LLC

  • Somewhat expensive formation and maintenance – More costly to establish than a sole proprietorship or partnership and LLC’s must file an annual report, and the fee can cost hundreds of dollars
  • Potential Funding challenges – One of the disadvantages of an LLC is when ownership needs an injection of cash or money. If the LLC had gotten turned down for a bank loan, it could be difficult for the owner to attract money from outside investors. A corporation might be able to raise cash from venture capitalist firms, which provide money to businesses in exchange for a share of the profits. Venture capitalists usually only fund corporations and not privately-owned LLCs.
  • Limited Liability can have limits – In a court proceeding, a judge can rule that your LLC structure doesn’t protect your personal assets. The action is called “piercing the corporate veil,” and you can be at risk for it if, for example, you don’t clearly separate business transactions from personal, or if you’ve been shown to have run the business fraudulently in ways that resulted in losses for others.
  • Self-Employment Tax – By default, the IRS considers LLCs the same as partnerships for tax purposes, unless members opt to be taxed as a corporation. If your LLC is taxed as a partnership, the government considers members who work for the business to be self-employed. This means those members are personally responsible for paying Social Security and Medicare taxes, which are collectively known as self-employment tax and based on the business’s total net earnings.
  • Member turnover – In many states, if a member leaves the company, goes bankrupt or dies, the LLC must be dissolved and the remaining members are responsible for all remaining legal and financial obligations necessary to terminate the business. These members can still do business, of course; they’ll just have to start a whole new LLC from scratch.

Limited Liability Company – LLC Key Takeaways

For LLC’s, business operations are much simpler, and the requirements are minimal.
An LLC is a type of business entity that’s owned by its members. The entity is separate from the members.
Simple to set up and maintain – no annual meetings, formal officers, or complicated records.
Limited liability companies are taxed differently from other corporations. An LLC allows pass-through taxation, which is when the business income or losses pass through the business and are instead recorded on the owner’s personal tax return. An LLC with multiple owners would be taxed as a partnership, meaning each owner would report profit and losses on their personal tax return.
Easy to setup and maintain and cheaper than other business types
LLC’s have very little restrictions regarding the company’s structure. You decide if you want your business to be a single member LLC, multi-member LLC, and so on.

Doing Business As (DBA)

A DBA isn’t a business structure and doesn’t provide any personal asset protection like an LLC or corporation.

It is simply using a different name to operate your business under.

One common misconception is that a DBA is a type of business structure or business entity.

A DBA is not a business entity, it is simply another registered name for your business.

A Doing Business As (DBA), also known as fictitious business names, trade names, or an assumed name, is a name that the legal owners of a business register with the state.

Owners must register a DBA only if they use a different name on items like business signs, letterheads, advertisements, and so on.

This DBA name is something other than the names of the legal owners of the business (for sole proprietors and partnerships) or the business name the owners listed on the formation paperwork (for LLCs and corporations).

DBA’s are not required or needed to run a business, but sometimes they are needed.

DBA’s are often used by partnerships, sole proprietorships, LLCs and corporations for branding purposes.

To actually establish your business once you decide on a business entity type, you will generally have to register in the state in which your business is located.

Learn all about DBA’s and how they apply to different types of Business Entities here.

Conclusion

As you can see, business entities each have their own set of rules and regulations and their purpose based on your business scenario.

Ultimately, there is not a “one size fits all” approach when choosing a business entity because the choice you make will have an impact on your finances as well as you liability and risk.

The majority of entrepreneurs and small business owners start as an LLC because it offers limited liability protection as well as the benefits of pass-through taxation.

As your company grows, you can always incorporate your business by becoming a corporation.

If you have multiple partners, a general partnership or limited partnership might be a good starting point.

If you still aren’t sure which option is best for your business, you can always contact a legal or financial professional to point you in the right direction.

Related Articles:

Business Startup Checklist – A List of Things needed to Start a Business

How to Start an LLC – Step-by-Step Guide to Starting a Limited Liability Company

LLC Cost to Start or Form a New Limited Liability Company

Business Incorporation – Things to Know before Incorporating a Business

Best Business Formation Services

 

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  1. IRS.gov "Business Structures" Page 1. April 7, 2021

  2. SBA.gov "Choose a Business Structure" Page 1. April 7, 2021