Types of Entities
Recently, we introduced the idea of entities and why you might need one or more. Today, we’ll give you some brief perspective on them – although only an incomplete starter kit with a few ideas thrown in. Here are the major types of businesses most people would consider (there are more specialty types for particular businesses):
- Sole Proprietor (SP) – This is the simplest form of business in which everyone operates who has not taken the steps to set up their business in a more sophisticated entity. If you decide today to sell lemonade on your street corner and walk out there and do it, you are operating as a SP. This is not to demean this type of business as some SP’s can become quite successful and large. However, it is more difficult to take tax advantages operating as an SP and you are completely exposed to lawsuits. The business is not in any way separate from your family assets. There is no business continuity if anything happens to you as the proprietor.
- Partnership (P) – There are two types of P, General Partnerships (GP) and Limited Partnerships (LP). Usually Limited Partnerships are set up to be an investment opportunity, where one (or a few) partners are active in the business and act as General Partners while the investors act as limited partners. This allows the limited partners to share in the profits of the business with limited liability (along with no control) should the business be sued. One form of GP might be as simple as two or three friends going into business together in a very loose manner such as in the case of SP above. When there are multiple partners, this is a GP and therefore has the same issues as the SP, but with the added potential for disagreement amongst partners. A Family Limited Partnership (FLP) is a subset that is often used in estate planning to transfer significant wealth in units of ownership (to avoid estate taxes) while retaining control for the parents.
- Limited Liability Company (LLC) – This has become a very popular form of entity and is typically the best entity to set up to own long term (greater than 1 year) real estate holdings within. It gives protection from liability, so if someone sues your company they can not come after your personal assets. For example, if you own a rental property and your tenant sues you when they slip and fall on the floor of the home they’ve rented from you, they would sue the owner of the property. If that is you personally, they could potentially be awarded your personal assets. If it is an LLC which owns the property, they can only go after the assets of the LLC because it is a separate legal entity from you. The liability protection is perhaps a little stronger than the S-Corp we’ll discuss next when it’s owned by multiple parties (such as you and your spouse) because even if there is a claim against one of the owners, the distributions can be shifted unevenly to the owners (for instance your spouse). At the same time, the LLC is a Pass-Through tax entity which means that it will not have to pay its own taxes. Whatever profit or loss the LLC achieves will be passed through to your personal tax form.
- S-Corporation (S-Corp) – Is very similar to an LLC with a few differences. It is also a Pass-Through Tax vehicle, but it offers the additional advantages in reducing self employment taxes, so if you are earning Ordinary Income and have expenses, the S-Corp could give you tax advantages over the LLC. S-Corp’s also have limited liability protection for its owners, but must pay distributions in proportion to the ownership of its owners.
- C-Corporation (C-Corp) – These are typically for larger corporations. Exxon Mobil, Dell Computer, or just about any other large company you can name is probably a C-Corp. They pay their own taxes, so most individual business owners are unwilling to pay taxes at the corporate level and then have that money taxes again when received at the personal level. This can become the best, or only, option when trying to raise money from a large number of owners (stockholders).
Again, we are not accountants or attorneys, but are giving you a rough outline of the different types of businesses.
This post is _Part 17_, the last in the series The Rock. To use this as a growth tool, you might start by reading Pt 1, Pt 2, Pt 3, Pt 4, Pt 5, Pt 6, Pt 7, Pt 8, Pt 9, Pt 10, Pt 11, Pt 12, Pt 13, Pt 14, Pt 15 & Pt 16.
Photo credit: phil schatz