When starting a business, the choice of entity is an important decision that impacts various things, including, the way that the company operates, management authority, and ownership structure. Similarly, existing companies may consider changing their corporate form based on changing needs. The IRS recognizes five business entities for tax purposes:
- Sole Proprietorship
- S Corporation
- Limited Liability Company (LLC)
Note that although the IRS only recognizes five entities for tax purposes, there are many variations of these entities with different purposes, controls, limitations, etc.
Two of the defining characteristics of business entities are: whether they limit owners’ liability and their tax structure. Some business entities limit the owners’ liability – meaning that they provide a barrier between the business’ creditors and the owners’ personal assets. Second, there are two tax structures that apply to different entities: pass-through taxation where the businesses taxes are passed on to the owners, and corporate taxation where business is taxed as an independent entity and then profits after tax can be distributed to owners (e.g., shareholders).
A sole proprietorship is an unincorporated business owned by a single person or jointly owned by a married couple. A sole proprietorship receives pass-through taxation and does not generally limit an owner’s liability.
A partnership is a relationship between two or more persons who carry on a trade or business. Even if not registered for formally established, a partnership can be established when two or more persons carry on a trade or business. Although the IRS taxes all partnerships as pass-through entities, there are differing partnership entities that offer varying characteristics relating to control and limited liability, such as general partnerships, limited partnerships, limited liability partnerships, and limited liability limited partnerships.
A corporation is an incorporated entity that is taxed at the corporate level and shields owners (shareholders) from liability. Corporations have complex corporate governance and require certain corporate formalities to be met. Although more complex, corporations offer many benefits to businesses that may outweigh the added legal complexity.
An s-corporation is an incorporated entity subject to pass-through taxation and provides limited liability to shareholders. In addition to pass-through taxation, there are several other characteristics that distinguish an s-corporation from a corporation, such as having a limited number of shareholders.
An LLC is an extremely flexible business entity that offers less legal complexity than a corporation while allowing the business to elect to be taxed at the corporate level or subject to pass-through taxation. The LLC’s popularity is due to its middle-ground between the sole proprietorship and corporation in relation to cost and legal complexity, and the elective tax treatment is a major benefit for many businesses.
Business Lawyers Serving Augusta, Georgia
At Klosinski Overstreet, we have provided unparalleled legal advice and guidance to businesses of all sizes throughout Georgia. We help entrepreneurs, start-up businesses, and existing businesses structure their entity. If you are considering starting a business or have legal or tax questions pertaining to an existing business, please contact our office today to schedule a consultation.