Choosing the right legal entity for your business is a vital step in creating a startup. If you’re having trouble deciding which avenue to choose (sole proprietorship, limited liability company, co-op, etc.), we’ve compiled a comparison of each to help you decide what best suits your business goals.
Why is choosing a legal entity important?
Choosing what entity your business legally operates as is essential when you start a business because each entity has different legal and tax consequences for your business if not followed correctly. These entities offer different liability protections, which provide a degree of protection for an owner's personal assets from their business assets.
Businesses are also taxed differently depending on how they register. Corporations have more tax options than proprietorships or partnerships, though some, such as a C corporation, have double taxation—meaning their income and their shareholders’ distributions are both taxed.
Types of legal entities
Here are the five most common types of legal entities that businesses can register as. Read on to discover which is best for your business and its goals.
Sole proprietorship
A sole proprietorship is a business that is run by one person. It’s important to note that a sole proprietorship is different from an LLC owned or run by one person. A sole proprietor assumes full liability of their business for both legal and financial issues. If the business fails, the proprietor becomes burdened with all of its debt and their personal assets are at risk. As the business is operating as a single entity, sole proprietorships may be eligible for certain business tax and health insurance deductions.
Businesses are also taxed differently depending on how they register.
Partnership
A partnership is a business owned by two people. The two types are a general partnership, in which the business is shared equally, and a limited partnership, where one partner has majority control of the operations and the other contributes to and receives part of the profits. In a general partnership, each partner is personally liable for the financial and legal obligations of their partnership. However, in a limited partnership only one partner assumes the risk. The individual’s liability obligation depends on which type of partnership they are operating under. Partnerships typically do not have to pay income tax. Both partners are responsible to report their shared income or losses on their individual tax returns.
Limited liability company (LLC)
A limited liability company is a business entity that allows owners, partners or shareholders to limit their personal liabilities and have the tax flexibility of a partnership. LLCs have to be registered with the state and have a state filing fee, the cost of which depends on the state in which you're registering. LLCs protect their owners from personal liability including lawsuits, debt and other business obligations; they also have a bigger tax burden as they have to pay federal, state and local taxes, with some states requiring LLCs to pay state business tax and unemployment tax.
Corporation
Corporations are business entities that are separate from their owners and have their own legal rights. A corporation can sue, own and sell property and sell rights of ownership in the form of stocks. There are several types of corporations, including C corporations, S corporations, B corporations, closed corporations, open corporations and nonprofit corporations. The owners and stockholders of a corporation are not personally liable for any legal or financial claims against them. A corporation files its corporate taxes separately from one's personal taxes and its tax obligations depend on what kind of corporation it is registered as.
Cooperative (Co-op)
A cooperative (co-op) is a business entity that is owned by the same people that it serves. Its members or owners decide on the organization's mission, direction and profits. Like an LLC, the members of a co-op have limited liability for the legal and financial debts and obligations of the business. Co-ops do not tax their individual members on their income, only the organization as a whole.
CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.
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