Entity Selection

When starting a new business (or evaluating an already established business), the question of what type of entity to be is important. The main choices are C-Corps, S-Corps, LLPs, LLCs or unincorporated entities.

Regular Corporations (C-Corps) are not used very much anymore. There are certain types of income that will be taxed twice with a C-Corp. You would need to have a unique situation to justify a C-Corp.

Partnerships, or LLP’s, are good. They are sort of forced on you if you have unrelated people as owners. They are taxed similar to sole proprietors.

Most small business people have to choose between becoming an LLC or an S-Corp. They may also choose to do nothing and operate as an unincorporated sole proprietor. The unincorporated sole proprietor is what most business people have operated as for the last 100 years. An LLC is similar to the unincorporated sole proprietor, but is a “disregarded entity” in the eyes of the IRS. There is no tax benefit to a one person LLC. It is taxed exactly the same as the unincorporated sole proprietor, but it may give you a certain amount of legal coverage.

The S-Corp is more complex and has both legal and tax advantages. An S-Corp has the ability to make money without having all the profit subject to the 15% SE tax. All profits of LLCs, LLPs and unincorporated sole proprietors have 15% SE tax on every dollar. Being an S-Corp sounds good, but you need to have the right type of business to qualify. You need to earn money off your employees and/or because of the financial risk and investment you have made. A restaurant is a good example. They have both employees and a large cash investment, with a great deal of risk. You are allowed to pay the owner a “dividend” for his investment risk. Owners must also be paid a “reasonable wage” for their efforts.

In the right situations, an S-Corp is great. Some businesses, like mine for example, don’t fit the correct profile for an S-Corp. I have very little cash invested and I don’t have employees. Most consulting businesses will not qualify as an S-Corp. They do not make money unless they put in the time and brainpower.