Sole Proprietorship, Partnership, LLC or Corporation: What’s Right for Your Business?

By QuickBooks

4 min read

Selecting the right business entity is an important decision that could spell the difference between success, failure, personal asset protection and tax obligations. There isn’t one business entity that is ideal for every single business. Your ideal entity depends on several factors, including your industry, location, number of owners and exit strategy.

As a business owner, you should conduct due diligence by impartially considering the benefits and disadvantages of each business entity. Did you know that some entities put your personal bank accounts at risk? Did you know some entities must pay significantly more taxes than others?

Read our summaries and watch the videos below for an overview of each business entity, including their benefits and disadvantages.

Starting With the Basics: Sole Proprietorship

Sole proprietorships are the most common and easiest business structure to form. Sole proprietorships are only allowed for businesses with one owner, and there is no legal distinction between an owner and the business in a sole proprietorship.

Its main benefits include preferable taxation treatment and ease to set up. However, an owner’s personal assets are at risk and can be used to pay the business’ debts or obligations, such as lawsuits.

If you want to learn more about sole proprietorships, check out our overview of their pros and cons. For a step-by-step guide to creating a sole proprietorship, click here.

Two or More Persons: Partnerships

A partnership is owned by two or more persons and is run for a profit. Similar to a sole proprietorship, a partnership is easy to form with minimal upfront costs. Each partner can contribute money, labor or skills in return for an ownership stake in the business.

Its main advantages include taxation benefits and ease to set up. However, personal liability for business obligations is a significant drawback. In addition, partners can disagree on material issues, which can lead to tedious legal battles. Consider implementing a partnership agreement to minimize such risks.

For more insight on partnerships, click here. If you’re convinced a partnership is right for you, see our step-by-step guide to creating a partnership.

The New Kid: Limited Liability Companies

A relatively recent incarnation, LLCs started sprouting up a few decades ago. Created and governed entirely under state law, LLC owners must elect how they want to be taxed by the IRS (e.g. as a sole proprietorship, partnership or corporation).

LLCs offer practicality and flexibility. They combine the limited liability of corporations with the taxation benefits of partnerships. However, depending on state law, they can cease to exist if an owner departs or dies.

For more info on LLCs, see our overview here. To get started on forming an LLC, check out our guide to creating an LLC.

The Big Business Entity: C Corporations

If you have aspirations of going public on a stock exchange, a C corporation is your ideal route. Considered a distinct legal entity from its owners (called “shareholders”), C corporations provide limited liability protection to shareholders, insulating personal assets from business debts.

However, C corporations are subject to “double taxation” and don’t receive preferential tax treatment. The C corporation’s profits are taxed once at the corporate level, and shareholders are taxed again at the individual level. In addition, if complex formalities aren’t followed, shareholders can forfeit their limited liability status and be held personally liable for the C corporation’s debts and obligations.

If you want to learn more about C corporations, see our article on their pros and cons. For a step-by-step guide to creating a C corporation, click here.

The Small Business Alternative: S Corporations

Another recent incarnation, S corporations offer small businesses taxation relief. Considered the little sister of C corporations, S corporations combine the limited liability protection of C corporations with the taxation benefits of sole proprietorships and partnerships.

On the other hand, not all businesses will be eligible for S corporation election. If you have more than 100 shareholders or have shareholders that are not natural individuals, you will not be eligible for S corporation election. Additionally, shareholders can lose their limited liability protection if corporate formalities aren’t followed.

To learn about the benefits and drawbacks of S corporations, click here. If you’re ready to get started, check out our complete guide to creating an S corporation.

Take Your Time and Consider Your Options

As you can see, selecting a business entity is not as easy as it seems. It’s imperative that you take your time and do research before selecting a business entity that’s right for you.

Although you may be exposing yourself to personal liability, consider starting as a sole proprietorship, and if you enjoy initial success, incorporate or form an LLC accordingly.

Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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