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Most people have heard a few things about the types of business entity, such as sole proprietorship, partnership, limited liability company, s-corporation and corporation.

Once you have a bright business idea,  usually the next important thing is to choose a form of business.   At times, the choices of business entity seem confusing, but in a nutshell it is just the level of taxation and legal protection you have to choose for your business.

Behind all these business entities,  the essential concept is just the degree of  connection between you and your business.  Naturally, you represent your business, so the business and you are just one “person”.  On the other hand, you can declare that your business is a total different “person” from you.

Sole Proprietorship

You and your business are one, so you will have to personally bear the obligations for your business, and income from the business will be taxed as your personal income.

It is almost a no brainier to set this up, but being personally responsible means you can lose all your personal assets or properties if things go wrong for the business.  That is scary, so the next good thing is to have a partnership.

Partnership

You will split the business income with partners in a partnership and everyone will pay their own income tax.  That makes sense if you need funds or skills from other people to run your business.  It lower your legal risks by spreading among your partners.  Well, as you can tell you are still personally at risk.

Corporation

You declare that your business is a total separate entity by a process called  incorporation.  You will contribute funds as shareholder to the company. The company will answer to its own problem, and in the worse case, all you will lose is your investment.  A corporation has more tax deduction advantage, however, as a separate “person”, it pays its own income tax.  When the company returns profit to you as dividend to your investment, you will be taxed again.  To maintain this status, there are many procedure to follow every year, such as having stockholder meeting and keep meeting minutes.

S-Corporation

To avoid the double-taxation of corporation, a corporation can elect to be treated as sub-charter S corporation.  Basically, it is a exceptional tax rule that allow the corporation not to pay tax, but pass all the income or loss to its shareholders.  This is quite useful, if you expect the business will generate losses for a certain period.

Limited Liability Company (LLC)

This has become a popular form of business because it will give you the benefit of limited liability without the double taxation of a corporation.  It is set up based on state laws, so it is very important to have it set up correctly.  IRS does not recognize this entity and it is usually taxed as sole proprietorship or partnership.

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