You’ve got the vision and the momentum—now it’s time to choose the right business entity.
Whether you're starting a new business or you've been established for years, it's important to know the different types of business entities and which one is the best fit for you.
It’s not the most exciting task, but a smart choice here will save you headaches (and late-night Google searches) down the road.
What’s a Business Entity Anyway?
A business entity is the legal identity of your business. It determines your liability, how you're taxed, and how your earnings, income, and profit are reported to the IRS.
Simply put, it’s how the IRS sees you and your business, dictating your liability and how much of your hard-earned money Uncle Sam will claim.
How Do I Determine My Business Entity?
Everyone approaches this decision differently. You may be more concerned with paying less in taxes, or perhaps protecting your personal assets is more important. Often, it’s both.
When choosing your business entity, it’s important to think through your business goals and the long-term vision you have for your company. Let’s explore the most common options available to you.
- Sole Proprietorship
- General Partnership
- Limited Partnership
- Limited Liability Partnership
- S-Corporation
- C-Corporation
- Limited Liability Company (LLC)
What Is a Sole Proprietorship and When Should You Choose It?
A sole proprietorship is the simplest form of business ownership. If you’re a single person (or married couple) in business, there’s no legal or tax distinction between you and your business.
This means that whether you’re a freelance graphic designer or selling products on Etsy, you are automatically considered a sole proprietor under state law. Here are some key points to remember:
- You do not need to register with the state.
- Your business is included on your personal tax return.
- You’re responsible for all business expenses, debts, and profits.
- You are personally liable if your business is sued, putting your personal assets at risk.
Pros of a Sole Proprietorship
No registration costs
Since you don’t register with the state, starting a sole proprietorship is free.
Tax benefits
You achieve pass-through taxation, meaning your business income is reported on your personal tax return. You can also deduct business expenses, such as office supplies, electronics, etc.
Cons of a Sole Proprietorship
Unlimited liability
Your personal assets are at risk if you face lawsuits or business debt.
Limited growth potential
You can’t seek outside investment in order to grow because you can't sell or share stocks in your business.
What You Need to Know About General Partnerships
A general partnership is similar to a sole proprietorship but involves two or more people. You don’t have to register your partnership with the state, and just like a sole proprietorship, there is no limit to your liability—your personal assets are still at risk.
The main difference is that profits and losses are divided between partners. It's important to meet with an attorney and have a formal agreement with your partner because you are both sharing the fortune (and possible misfortunes) of the business.
Pros of a General Partnership
No registration costs
Similar to a sole proprietorship, you are not registered with the state, so you aren't paying anything out of pocket for a business entity.
Shared responsibility
Profits and losses are shared between you and your partner(s).
Cons of a General Partnership
Unlimited liability
Not only are you liable for your actions, but you are also liable for your partner’s actions.
Potential for conflict
Without a clear legal agreement, disputes over responsibilities and profits can arise.
Limited Partnership: When You Need Investment
A limited partnership (LP) is a business structure that involves two types of partners: general partners who manage the business and limited partners who invest but don’t run the day-to-day operations. Limited partners’ liability is restricted to the amount they have invested.
In a limited partnership, you are registered with the state. Because of this, you are only liable for the personal and business assets that you have contributed.
If you need to raise money for your company quickly, a limited partnership is a great option that still protects you and your assets while also empowering you to retain your authority over your business.
Pros of a Limited Partnership
Liability protection for limited partners
Limited partners are only liable for the amount they’ve invested.
Access to capital
LPs are great for raising money while allowing general partners to retain control of the business.
Cons of a Limited Partnership
Complex setup
Registering as an LP can be more complicated and costly than a sole proprietorship or general partnership.
General partners’ liability
General partners still face unlimited liability, meaning personal assets could be at risk.
Limited Liability Partnership (LLP): Protecting Both Partners
In a limited liability partnership (LLP), both partners are protected from each other’s liabilities. This structure is popular for professional service businesses such as law firms and medical practices.
For instance, if you own a veterinary clinic with other vets and one of them is sued for malpractice, you won’t be personally liable for their actions.
Pros of an LLP
Liability protection
You’re protected from lawsuits or issues caused by your partner(s).
Separate tax reporting
LLPs often allow partners to report business income on their personal tax returns, avoiding double taxation.
Cons of an LLP
State-specific regulations
Not all states allow LLPs, so you’ll need to check your local regulations.
Complexity
Setting up an LLP can be more complex than other business types.
S-Corporation: The Hybrid Option
A small business corporation, or S-Corp, offers the liability protection of a corporation combined with the flexibility of an LLC.
However, there are specific requirements to qualify for S-Corp status.
- You have to be a domestic company
- You can't have partnerships
- Individuals must be U.S. citizens and live in the state
- You can have no more than 100 shareholders
Pros of an S-Corp
Tax benefits
An S-Corp prevents double taxation. The business itself isn’t taxed; instead, income is passed through to shareholders, who report it on their individual tax returns.
Liability protection
Like other corporations, an S-Corp protects owners from personal liability.
Cons of an S-Corp
Strict requirements
S-Corps have limitations on the number of shareholders and types of ownership structures allowed.
State-dependent benefits
S-Corp benefits vary by state, so they may not be the best option everywhere.
C-Corporation: Best for Large Companies
A C-Corporation (C-Corp) is a completely separate legal entity from its owners. This setup is ideal for businesses that plan to scale and attract investors, as it allows for selling stock to the public and raising capital quickly.
However, C-Corps are subject to double taxation—the corporation pays taxes on its profits, and shareholders also pay taxes on dividends they receive.
For example, if your C-Corp earns $100,000, the company must pay taxes on that income before distributing any money to you as an owner. Once the corporation pays its taxes, if you take money out as a dividend, you’ll also have to pay personal taxes on that—essentially getting taxed twice (once at the corporate level and again at the individual level).
As an owner, if you receive a bonus instead of a dividend, you’ll still need to pay taxes on that bonus as part of your personal income.
Pros of a C-Corp
Growth potential
C-Corps allow for faster growth since you can sell stock to the public and borrow money more easily.
Liability protection
Owners aren’t personally liable for the company’s debts or legal issues because the business is considered a separate entity from you.
Cons of a C-Corp
Double taxation
A C-Corp is taxed twice—once on the company’s profits and again when dividends are paid to shareholders, which can cut into overall earnings.
Complexity
C-Corps require more paperwork and legal filings than other business structures and are expensive to maintain due to additional fees and regulations. Managing multiple partners or shareholders with different contributions can add to the complexity.
LLC: The Flexible Option for Many Businesses
A Limited Liability Company (LLC) consists of all limited partners, which means that you are limited to your own liability. You are personally protected from the business and the actions of the other partners.
With an LLC, you can be taxed in two different ways: as a partnership (default) or as a corporation, which means you will file and pay your own tax returns, and individuals have no tax consequences. An LLC is like a mix between a corporation and a partnership. It protects against personal liability, but it has the flexibility of a general partnership for tax purposes.
At Patrick Accounting, we work with LLCs all the time—and for good reason. In Tennessee, where there’s no state income tax, LLCs offer more flexibility and simplicity than S-Corporations, making them the practical option for most owners.
Pros of an LLC
Liability protection
Owners are shielded from personal liability for the company’s debts or lawsuits.
Flexibility
LLCs offer a flexible structure. You can easily add or remove partners and manage the flow of money—whether it’s borrowing, investing, or withdrawing funds.
Cons of an LLC
Self-employment taxes
In most cases, LLC members are subject to self-employment tax on their earnings, as the IRS typically treats them like sole proprietors.
Professional setup recommended
While it’s possible to set up an LLC yourself, we recommend consulting a lawyer or accountant to avoid potential issues.
Wondering whether an LLC or S-Corp is the right choice? See which one could save you more on taxes here.
How Do I Choose the Best Entity for My Business?
When choosing your business entity, it’s important to consider the following factors:
- Location: Different states have different tax structures and regulations, so where you’re located will play a significant role in your decision.
- Type of business: Some business models, like tech startups, may benefit from structures that allow for investment opportunities. Others, like professional services, may lean towards partnerships.
- Liability risk: Consider how much risk is associated with your business. Are you offering services or products that could lead to lawsuits? Your liability exposure will influence your choice.
Set Your Business Up for Success—It All Starts Here
Choosing the right business entity is a foundational decision that will shape the future of your business. Whether you’re prioritizing liability protection, tax savings, or flexibility, the right structure can set you up for success.
At Patrick Accounting, we recommend always hiring and consulting your lawyer and accountant when trying to figure out which business entity is best for you. It helps you avoid making a mistake and helps you focus on the passion behind you and your company.
Choosing the right business entity is just one step in managing your taxes effectively. Make sure you're ready for tax season—check out our guide here to feel confident and prepared.
