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By Mark L. Sullivan, CPA

There are many decisions new small-business owners must face. One of the most impactful, though, is determining the type of entity the business will be. To determine the best entity choice for you and your small business, you must first consider certain circumstances specific to you. Do you have personal assets that you want to protect? How is the entity going to be financed? Will other business interests or people be affected?

Below is a quick overview of some of the options.

Sole Proprietor

This is a simple entity to create since it already exists: it’s you. This model is easy and inexpensive to set in motion. With your Social Security number, a name that can be your name or a "doing business as" name, and the required state and local business filings, you have an entity. One must be careful with this choice. Since you are considered the business entity, your personal assets can be at risk. There is no protection to the owner from legal issues such as bankruptcy or creditor and other legal liability issues.

Partnership

This formation includes an agreement between two or more parties for a business purpose. The parties could be individuals, partnerships, or other businesses. The formation of a partnership is typically simple, but it becomes more complex with accounting and tax issues, such as partnership capital and liability. Partnerships create a pass-through entity that could be beneficial for tax purposes.

Corporation

Corporations require more effort to establish. The business becomes its own entity within the state that incorporates it. This provides the entity and its shareholders with protections from legal issues. One of the drawbacks of a corporation is that the business income is taxed at a corporate level, and when it is distributed to shareholders it is taxed as a dividend. An option for a corporation that qualifies would be to register as an S corporation, creating a pass-through entity. This allows the income or loss to pass to the individual shareholders as a percentage of their ownership in the entity.

Limited Liability Company (LLC)

Similar to a corporation, an LLC provides the flexibility of a sole proprietorship with the protections of a corporation. The LLC can be treated as a corporation, partnership, or as a disregarded entity. Its owners can be individuals, partnerships, trusts, corporations, or other LLCs. The set up and filings of an LLC determine how the business will be taxed.

Beyond these basics, there are many legal and tax issues to be discussed before deciding on an entity structure. The changes brought on by the Tax Cuts and Jobs Act of 2017 will also influence any decision. John Steffee, CPA, recently wrote a blog “Clarifying Small Business Deductions under the Tax Cuts and Jobs Act” that addresses some of the changes. 

Filing taxes is a burdensome process for most small businesses. The IRS provides for consideration a look at the tax filing requirements for each entity. 

When determining your business’s entity type, discuss your particular situation with a CPA and a lawyer to make sure you choose the best fit for your business.

Mark Sullivan, CPA, is the controller at K&I Sheet Metal Inc. in Pittsburgh, Pa. He is an active member of the PICPA and serves on the CPA Image Enhancement Committee.