Legal types of business entities
What types of business structures can you form and how do you choose one?*
When starting your business, you’ll eventually need to decide what form of business entity to establish. Your business entity determines which income tax return form you have to file as well as the amount of paperwork your business is required to do, the personal liability you face and your ability to raise money and take tax-deductible donations.
When you start a business, you will want to start one of the following three types of businesses:
A traditional for-profit business - where your primary goal is to make a profit.
A non-profit organization - where your primary goal is to fulfill a social, religious, or educational mission.
A social enterprise - where your goal is both to fulfill a social mission and to make a profit.
Depending on your goals, you’ll also have to choose from one of several types of legal entities or structures. The most common business entities are the corporation (S-Corp or C-Corp), LLC, partnership, sole proprietorship and not-for-profit or 501(c)(3). We’ve provided an overview of business types below, but make sure you check the federal, state and local legal and tax considerations for your preferred business entity before making it official.
*Disclaimer: Legal Information Is Not Legal Advice This educational program (“Program”) is a service provided by Skysthelimit.org / Youth Business USA (“YBUSA”) and it provides general information related to the law designed to help users safely cope with their own legal needs. This Program does not provide legal advice and Skysthelimit.org is not a law firm. None of our staff are lawyers and they also do not provide legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a lawyer if you want legal advice. You may Explore the Community to find a Volunteer Legal Expert who may be willing to provide pro-bono (free) legal advise.
What are the advantages and disadvantages of each business type?
Each type of business will have pros and cons. We’ve briefly described each of the main business entities below. Click the links for a full explanation and a list of advantages and disadvantages for each.
Sole Proprietorship: A sole proprietorship is an unincorporated business, where the founder owns it by herself.
Corporation: A form of organization that provides its owners and shareholders with certain rights and privileges, including protection from personal liability.
Partnership: A partnerships is a relationship existing between two or more persons who join together to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business. Two common types of business partnerships are a general partnership and a limited partnership.
Limited Liability Company (LLC): An LLC is a business structure that provides limited liability for the owners or members. This is a popular structure because it means the owners of the company are not personally liable for their company's debts or liabilities.
501(c)(3): Nonprofits are tax-exempt or charitable, meaning they do not pay income tax on the money that they receive for their organization. They tend to have religious, scientific, research, or educational missions.
Social Enterprise: Social enterprises can be set up as a nonprofit, for-profit, or hybrid business entity. Most often, they are set up to solve a social problem using a traditional business approach.
How do you choose the right type of entity for your business?
Choosing the right type of entity for your business will impact everything from day-to-day operations, to taxes, to how much of your personal assets are at risk, to the ease with which you can get a small business loan or raise money from investors. And if someone sues your business, your business entity structure determines your risk exposure. You should choose a business structure that gives you the right balance of legal protections and benefits.
You'll need to choose a business structure before you register your business with the state. Most businesses will also need to get a tax ID number, or EID, and file for the appropriate licenses and permits.
Keep the following in mind when deciding among the different types of business entities:
As a starting point, though, there are three general factors to consider when choosing among business entity types: legal protection, tax treatment, and paperwork (government) requirements.
Sole props and general partnerships are good “starter” entities.
As your business grows and generates more income, consider registering as an LLC or corp.
Consult a business lawyer and accountant to get specific help for your business.
Pro Tip
The business entity you establish will determine which income tax return form you have to file, as you read more through the IRS of the Small Business Administration make a list of pros and cons for each type of entity and ask your mentor to go over the list with you to help you make your decision.