When starting a business, defining its entity type is crucial for the future of the company. How you define your business will help determine how it operates, how it is taxed, and more. This article discusses the most commonly used business entities in the United States: sole proprietorships, partnerships, and corporations.
What is a sole proprietorship? A sole proprietorship is a business owned and operated by one person. In this type of business entity, there is no legal difference between the personal life of the owner and the business. The business is 100 percent owned by the individual and that the business’s assets solely belong to the owner. Sole proprietorships usually consist of small businesses, such as small start-ups, restaurants, barbershops, and small retail stores.
Advantages of a sole proprietorship: The biggest advantage of a sole proprietorship is that the owner is only taxed once. This differs from a corporation, where the owners are taxed both for the corporation’s earnings and then again for individual salaries (more on this below). For a sole proprietorship, the owner reports his or her earnings and costs from the business as part of his or her individual tax returns.
Another advantage of a sole proprietorship is that it is easy to set up. The government requires very little paperwork and the owner does not have to jump through any hoops to start his or her business. Sole proprietorships are also subject to fewer regulations, which makes running the business easier.
Disadvantages of a sole proprietorship: The main disadvantage of running a sole proprietorship is that the owner is subjected to unlimited liability. If the business goes under, the owner is responsible for 100 percent of the company’s debt. This is in contrast to a corporation, where the owners are not liable for all debt and can more easily walk away from a failed business (more on this below).
What is a partnership? In general, a partnership is the same as a sole proprietorship, but with more than one person owning and operating the business.
Advantages of a partnership: Partnerships have the same advantages as sole proprietorships, seeing as they are essentially the same thing. That being said, partnerships come with additional advantages. The main additional advantage of a partnership is that multiple people run the company, meaning they split the liability in case the company fails.
Disadvantages of a partnership: Similar to sole proprietorships, owners of a partnership assume 100 percent liability. Another disadvantage of a partnership is that partners can often disagree on the direction of the company, which can lead to leadership and management issues.
What is a corporation? A corporation is a business that is legally separate from its owners. This is unlike sole proprietorships and partnerships, where the owners and businesses are one legal entity. Instead of being owned by one or a few people, corporations are owned by shareholders. Some smaller corporations may be owned by a few dozen shareholders, while some larger corporations, such as Apple, Google, or other large tech companies, are divided into billions of shares owned by a mixture of individual investors and investment firms.
There are a few different types of corporations, and choosing the right type is important. We won’t go into detail on each one here, but check out the U.S. Small Business Administration for more information on specific types of corporations.
Advantages of a corporation: Classifying your business as a corporation has two key benefits. First, corporations have limited liability, which means if the company fails, shareholders will not be liable for all debt. Secondly, raising capital for a corporation is much easier than doing so for a sole proprietorship or partnership. This is because investors do not have to worry about one or a few bad owners having too much control over the company.
Disadvantages of a corporation: There are two key disadvantages of starting a corporation. First, those who run corporations are taxed twice: once at the business level and once again at the individual level. If you start a corporation, you will be taxed on the earnings of your business, and again on your personal earnings. This is unlike a sole proprietorship or partnership, where you will only be taxed once for everything.
The second key disadvantage is that corporations have high start-up costs. It is time-consuming and expensive to set up company bylaws and charters. You will have to consult with attorneys and experts in the field to ensure everything is done properly.
The type of business entity you choose will depend on what you are trying to do, and it is important you choose the right path. If you need assistance with starting your business, please don’t hesitate to reach out. Krowne Certified Public Accountants offer unparalleled financial guidance and professional services specifically tailored to our client’s needs. Please feel free to reach out to us at Krowne Certified Public Accountants by filling out the form on our contact us page or via phone at 818-831-6075. We would love to discuss your situation and help you grow. We look forward to hearing from you.