Business Entity Selection

Choosing which entity is appropriate depends on a variety of factors, they include the owner’s needs and desires, the type of business that will be taking place and the needs of the business in question. Additionally, both state and federal tax laws should be taken into consideration as they play an integral role; specifically, in closely held businesses when the owner’s tax liability needs to be part of the decision-making process. The primary choices are as follows:

Sole Proprietorship

General – A sole proprietorship, or sole-prop, is the simplest and most common structure chosen to start a business. It is an unincorporated business owned and run by one individual with no distinction between the business and you, the owner. You are entitled to all profits and are responsible for all your business’s debts, losses and liabilities.

Forming a Sole Proprietorship

You do not have to take any formal action to form a sole proprietorship. As long as you are the only owner, this status automatically comes from your business activities. In fact, you may already own one without knowing it. If you are a freelance writer, for example, you are a sole proprietor.

But like all businesses, you need to obtain the necessary licenses and permits. Regulations vary by industry, state and locality. Use the Licensing & Permits tool to find a listing of federal, state and local permits, licenses and registrations you’ll need to run a business.

If you choose to operate under a name different than your own, you will most likely have to file a fictitious name (also known as an assumed name, trade name, or DBA name, short for “doing business as”). You must choose an original name; it cannot already be claimed by another business.

Sole Proprietor Taxes

Because you and your business are one and the same, the business itself is not taxed separately-the sole proprietorship income is your income. You report income and/or losses and expenses with a Schedule C and the standard Form 1040. The “bottom-line amount” from Schedule C transfers to your personal tax return. It’s your responsibility to withhold and pay all income taxes, including self-employment and estimated taxes. You can find more information about sole proprietorship taxes and other forms at

Advantages of a 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.
  • 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.

Disadvantages of a 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.

Hard to raise money. Sole proprietors often face challenges when trying to raise money. You cannot sell stock in the business, which limits investor opportunity. 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.

Heavy burden. The flipside of complete control is the burden and pressure it can impose. You alone are ultimately responsible for the successes and failures of your business.

General Partnership

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, any partner may be sued for the business’s debts.

Each is responsible for their personal tax liabilities—including partnership earnings—on their income tax returns as taxes do not flow through the general partnership.
Understanding General Partnerships

General partnerships offer participants the flexibility to structure their businesses however they see fit, giving partners the ability to control operations more closely. This allows for more swift and decisive management as compared to corporations, which must often slog through multiple levels of bureaucracy and red tape, further complicating and slowing down the implementation of new ideas.
A general partnership must satisfy the following conditions:
The partnership must minimally include two 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.

General Partnership Features

In a general partnership, each partner has the agency to unilaterally enter into binding agreements, contracts, or business deals, and all other partners are consequently obligated to adhere to those terms. Not surprisingly, such activities may lead to disagreements; as a result, many successful general partnerships build conflict resolution mechanisms into their partnership agreements.

In some cases, the partners agree only to proceed with major decisions if there’s either a complete consensus or a majority vote. In other cases, the partners designate non-partner appointees to manage the partnerships, similar to a company’s board of directors. In any case, a broad agreement is essential because when all partners have unlimited liability, even innocent players can be fiscally on the hook when the other partners commit inappropriate or illegal actions.

General partnerships typically dissolve when one partner dies, becomes disabled, or exits the partnership. Provisions may be written into an agreement that provides directives for moving forward during these situations. For example, the agreement may stipulate that the deceased partner’s interest is transferred to the surviving partners or a successor.

Benefits of General Partnership

The cost of creating a general partnership is less expensive than setting up a corporation or a limited liability partnership like an LLC. General partnerships likewise involve substantially less paperwork. Case in point: In the United States, filing limited partnership paperwork with a state is generally not required, though certain registration forms, permits, and licenses may be necessary at the local level


A corporation, sometimes called a C corp, is a legal entity that’s separate from its owners. Corporations can make a profit, be taxed, and can be held legally liable.

Corporations offer the strongest protection to its owners from personal liability, but the cost to form a corporation is higher than other structures. Corporations also require more extensive record-keeping, operational processes, and reporting.

Unlike sole proprietors, partnerships, and LLCs, corporations pay income tax on their profits. In some cases, corporate profits are taxed twice — first, when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns.

Corporations have a completely independent life separate from its shareholders. If a shareholder leaves the company or sells his or her shares, the C corp can continue doing business relatively undisturbed.

Corporations have an advantage when it comes to raising capital because they can raise funds through the sale of stock, which can also be a benefit in attracting employees.

Corporations can be a good choice for medium- or higher-risk businesses, businesses that need to raise money, and businesses that plan to “go public” or eventually be sold.

S corp

An S corporation, sometimes called an S corp, is a special type of corporation that’s designed to avoid the double taxation drawback of regular C corps. S corps allow profits, and some losses, to be passed through directly to owners’ personal income without ever being subject to corporate tax rates.

Not all states tax S corps equally, but most recognize them the same way the federal government does and taxes the shareholders accordingly. Some states tax S corps on profits above a specified limit and other states don’t recognize the S corp election at all, simply treating the business as a C corp.

S corps must file with the IRS to get S corp status, a different process from registering with their state.

There are special limits on S corps. S corps can’t have more than 100 shareholders, and all shareholders must be U.S. citizens. You’ll still have to follow strict filing and operational processes of a C corp.

S corps also have an independent life, just like C corps. If a shareholder leaves the company or sells his or her shares, the S corp can continue doing business relatively undisturbed.

S corps can be a good choice for a businesses that would otherwise be a C corp, but meet the criteria to file as an S corp. Limited liability company (LLC) 

An LLC lets you take advantage of the benefits of both the corporation and partnership business structures.

LLCs protect you from personal liability in most instances, your personal assets — like your vehicle, house, and savings accounts — won’t be at risk in case your LLC faces bankruptcy or lawsuits.

Profits and losses can get passed through to your personal income without facing corporate taxes. However, members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security.

LLCs can have a limited life in many states. When a member joins or leaves an LLC, some states may require the LLC to be dissolved and re-formed with new membership — unless there’s already an agreement in place within the LLC for buying, selling, and transferring ownership.

LLCs can be a good choice for medium- or higher-risk businesses, owners with significant personal assets they want to be protected, and owners who want to pay a lower tax rate than they would with a corporation.

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