Types of Business Organizations to Consider
The types of business organizations available to entrepreneurs depend on what they want. There’s a wide range of considerations to coming up with the type of business entity desired.
It goes into how much complexity you want or need to have in the business:
- Do you have employees?
- Are you a one-man show?
- Do you need liability protection?
Those are some things to consider when thinking about what type of business entity you want.
Business Entities and their Pros and Cons
There’s a wider variety of types of business organizations, depending on what you need.
On the simpler side, you don’t have to do anything. You could start your business and you can do it as a sole proprietorship. You hang up your shingle or put an ad in the paper and say, “Hey, I do this for a living. Come on and hire me.” And it could be a great business and generate some income for you.
You have to report that on your taxes as an individual, you’d be a sole proprietor. And so that is one way of doing it.
On the more complex side, you could have a:
- Partnership if you have other people involved in the business
- Limited liability company and have a choice of different ways to tax your business
Whether it be a disregarded entity, that’s treated as a sole proprietor. Or you could treat it as an S corp or could create a C corporation. So there’s a lot of flavors of businesses.
And again, some of the pros and cons of the different entity types is one of the reasons why it’s created. It’s to foster investment in business and help the whole economy to do better.
One of the key aspects is liability protection. Business owners are always fearful they’ll get sued for doing something wrong. They may not have intended it usually, but they could get sued.
Somebody slips and falls in their store or they make something that hurt somebody. Lets say a vending machine falls and squashes somebody. You’re going to get sued on a situation like that. So the corporation in the limited liability companies can reduce the liability exposure. And that’s the reason they select that type of entity.
And there are certain aspects also that reduce your taxes. Like for example, an S corporation. S corporation is a tax designation, often used for an LLC, a limited liability company. But that allows you certain benefits from a tax standpoint.
The biggest one being it avoids the employment taxes from the business. So for example, if you have a sole proprietorship, all the net income of the business gets taxed to you. And you’ll have to have to pay self-employment taxes.
For example, you have to pay both the employer and the employee side of the social security. That’s about seven and a half percent for the employer, and seven and a half for the employee, about 15% a little bit more. But you have to fund that all yourself if you’re a sole proprietorship.
Benefits of S Corporations
One of the benefits of an S corporation is that the owner is able to choose a salary. It has to be reasonable according to the IRS. And they have some guidelines about what they feel is a reasonable salary and how you estimate what that is. But it allows you to avoid any self-employment taxes on the extra income from an S corp.
If the amount is more, for example, than your reasonable salary will only have the normal income taxes. So you have the opportunity to avoid a large amount of tax, and that’s the big benefits of an S corp. That’s one of the things to consider.
Again, it can help you to avoid income tax if possible. It’s legal — that’s why they invented it! They want businesses to have that benefit and create a more vibrant economy.