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For those of you wondering, which entity is best for my business? We thought we would provide a brief overview of entity types and their unique characteristics.  

Everyday I’m asked about entity types and structures, and what the benefits are to incorporating. And often, I’m asked to help clients choose between two entity types: such as choosing between an LLC or S CorporationAnd of course, clients want to know which entity will save the most on taxes.

If you’re asking yourself these questions, that means you’re thinking critically about what is best for your business — a smart move. And while we also advise on looping a lawyer into this conversation to advise on liability protection and requirements by state, our experience in guiding clients, some small, some very very large, is that tax and financial considerations are critical in selecting the right structure to minimize your tax obligations.

To that end, we’ve prepared a few key statistics, points, and definitions on entities, that will help you navigate the legal entity jargon.

By the Numbers

According to the IRS Statistics of Income, the most common type of entity is the S Corporation, followed by the LLC, when excluding the Sole Proprietor (which is not a legal entity).

The below table shows the number of tax returns filed with the IRS by entity type and the corresponding percentage of total business returns filed in 2012 (latest available).

 

Entity Type Returns Filed (Millions) (%)
C Corporation 1.6 17.5%
S Corporation 4.2 45.6%
General Partnership (GP) 0.6 6.3%
Limited Liability Partners (LLP) 0.4 4.4%
Limited Liability Company (LLC) 2.2 24.0%
Total* 9.2 100.0%

Source: Internal Revenue Service, SOI Tax Stats – Integrated Business Data
* Differences due to rounding.  

 

When including the Sole Proprietor and combining the above entity types into two categories: Partnerships vs. Corporations, we can begin to understand how big the Sole Proprietorships segment is, which perhaps explains why Sole Proprietorships are the most highly audited business filings.

 

Entity Type Returns Filed (Millions) (%)
Corporations (S and C Corporations) 5.8 17.8%
Partnerships (GP, LLP, and LLC) 3.2 9.8%
Sole Proprietorships (Non Farm) 23.6 71.8%
Total* 32.8 100.0%

Source: Internal Revenue Service, SOI Tax Stats – Integrated Business Data
* Differences due to rounding.  

 

Should I Incorporate?

Entities with Benefits

There are a handful of benefits to incorporating including:

  • Brand & Marketing – legitimacy in marketing a business name such as “LLP” or “Corporation” and the ability to sign contracts with a legal entity name   
  • Financial – ability to raise capital or borrow on business credit
  • Legal – personal protection from the liabilities of the business
  • Tax –  The ability to deduct expenses and costs you are not otherwise able to without a legal entity and the ability to set up a taxation structure

 

Costs of Maintaining Business Entities

On the flip side, there are also costs, which include:

  • Administrative – informational filings with the state and minutes for Board Meetings for Corporations
  • Tax – Separate tax returns for federal and state which may increase the professional fees as well as state-specific taxes

In our experience, the benefits in many instances outweigh the costs.

Entity Types

See below for entity types in the event to determine which entity is best for your business. Note that this is a very generalized overview. 

Sole Proprietorship

  • Definition: A Sole Proprietor is the owner of a revenue-generating unincorporated business with a profit and loss statement
  • Characteristics: Individuals or married couples in a for-profit business who may operate under a Doing Business As (“DBA”), but do not have a separate business entity
  • Taxes: All net profits are subject to Self Employment Tax and then are passed through as ordinary income to the personal return
  • Tax Forms: Schedule C on the 1040
  • Key Benefits: Simple and no paperwork is required

 

Partnerships

  • Definition: According to the IRS, a partnership is defined as the relationship existing between two or more persons who join to carry on a trade or business.
  • Characteristics: Partners are non employees and all parties contribute money, property, labor, and expect to share in the profits and losses of the business. Partnerships typically include General Partnerships, Limited Liability Partnerships, and Limited Liability Companies (where there is more than one managing member)
  • Taxes: Partnerships are subject to Self Employment Tax  
  • Tax Forms: Form 1065 and Form K-1 for individual partners
  • Key Benefits: Relatively simple to setup, maintain, and operate

 

Corporations

  • Definition: Corporations are entities held by shareholders who exchange money, property, or both for the corporation’s capital stock.
  • Characteristics: Corporations typically have several shareholders and are recognized as a separate tax-paying entity.  Most corporations are either C Corporations and S Corporations.
  • Taxes: S Corporation are not subject to Self Employment Tax (unlike partnerships) and not subject to double taxation. C Corporations are subject to the corporate tax and any distributions made to its shareholders are taxed at capital gains rates. Corporations are also subject to payroll reporting rules and require quarterly filings.
  • Tax Forms: Form 1120 for the C Corporation. Form 1120S for the S Corporation. In addition, S Corporation holders will receive a K-1 showing their portion of income or loss for the S Corporation.
  • Key Benefits: Provide liability via the “Corporate Veil,” and can take special deductions.

 

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