A Business entity is the type of business registration that you will apply to your business. This will determine selective treatments of transactions, your business decisions and your tax liabilities.
Liabilities (and savings) should be a business owner’s decision-making factor when it comes to considering a business entity type, not just the easiest and ,most convenient.
This article will introduce you to different business entities that you may choose for your business.
This is probably the most common among the business entities that you can apply to our eCommerce business. It means, you retain the power of ownership all throughout your business journey.
The major business decisions rely 100% unto you. Of course, later on, you may hire your own employees, but that does not mean that they are also owners of the business. Employees will always be an extra hand to you as you do your eCommerce business, but you as an owner, you may also be an employee of your business.
A shoe artisan, a dressmaker, a doctor, and many more are the owners and employees of their own business.
For this article, I will set an imaginary business that will help us understand the business entity types further.
Kayla, a 25-year old stay at home mom decided to put up a handmade crochet ready-to-wear dress for sale. Since she was passionate about it, she wants to sell her pieces online. Wanting to start her business in order, Kayla registered her business as a sole proprietorship.
There are many reasons why most businesses choose a sole propreitorship, but mainly, it is because it is less confusing and easy to manage.
- Easy to organize
- 100% share on the income of your business
- You may also register yourself as an ‘employee’ so that your salaries may be a tax deductible expense which can lower your taxes.
- Owners can withdraw their money anytime.
- Since the owner can also be the employee, they can claim employee benefits.
- No liability protection.
- Exposure is at 100% and anyone can claim up to the personal assets of the owner.
- Customers can see you personally instead of the business
Self employment taxes are at 15.3% and could increase.
Kayla, from our story above will now be paying taxes from all her revenues. She knows that she has to pay a ‘Self employment’ tax because her business is her major source of income. However, Kayla may need to pay more.
There are four (4) at minimum that a business owner will be liable and these are:
- Federal Income Tax
- State Income Tax
- Social Security Tax
- Medicare Tax
As a self-employed individual, you must file Schedule C Form 1040, which you can see here.
In her second year, Kayla thinks that she is having a hard time to manage her eCommerce business. Now, she considers the offer of her good friend Mary, who is also in the RTW dress business, however, Mary shops abroad. Kayla thinks it will still be a good addition to her business because Mary is very good in Marketing.
Now, Kayla and Mary organized a partnership.
General partnership is an unincorporated entity (either US or Non-US) with at least two owners, which is organized to carry on a trade or business.
Having no formal registration requirements, a general partnership may not be registered in a specific state.
Instead, a general partnership comes into an ‘entity’ as soon as two or more persons join together to own and operate a business. Ownership of a general partnership is in the form of partnership units, shares, or percentages.
There’s is no upper limit on the number of owners in a partnership (at least two), in addition, there are no restrictions on the kinds of owners that can be partners.
- There will be several decision makers in the business
- A partnership may have its own asset or partners may contribute their existing assets to the partnership
- The liability protection is the same as sole proprietorship
- The loans for the purpose of the partnership may be collected up to personal assets of the partners
With Partnership as your eCommerce Business Entity, you cannot be an employee. There are two ways to distribute payments to partners, one is through ‘guaranteed payments to partners’, and withdrawals.
Partnership tax filing is for informational filing only.
That means, you will need to report 100% of the income that the partners earned for the period. You must file for 1065 US Federal Tax Return but partnership entity does not need to pay taxes.
As partners get their fair share of the income and expense, they will have to file a k-1 Form 1065 and declare their share of income in the partnership.
Again, the partnership does not pay taxes, but the partners does. Having said that, a General partnership is a ‘pass-through’ entity.
Income of the partnership will be part of each partners’ income.
Kayla and Mary invested in sewing machines. This new partnership will be a stronger business than who they were a year ago. They wanted to add a line of formal gowns aside from crochet dresses and imported casual wears.
Kayla, with a good background in sewing, wants to be an employee however, a Partnership business entity will not allow Kayla to work as an employee.
One day, a huge fire caught the newly built establishment of Kayla and Mary. Unfortunately, another establishment was affected by the fire.
Their neighboring establishment filed claims against the Partnership. The money of the partnership will not suffice the damages. In the end, Kayla & Mary had to shell out their own personal money because the Partnership makes them liable up to their personal assets
Limited Liability Partnership (LLP)
When liability of the partners for the debts of the partnership is a problem, a limited partnership may be a solution.
Limited partnerships are generally not liable for debts of the partnership, but they must restrict participation in management of the partnership or risk loss of their limited liability.
In addition, a limited partnership requires at least one general partner.
LLPs are being taxed like the General Partnership.
Partnership business entities still need to file form 1065 but there’s no taxes paid on a partnership level.
Distributed income of the partnership will be filed with K-1 form by the partner.
A partner will pay its taxes together with all other income earned for the period (from other resources) or deducted with losses from other business aside from the partnership.
Learning from the fire accident, Kayla and Mary wanted to consider LLP but now, they lack personal funds. Although they find their business promising, they cannot quickly establish and finance the needs of their business.
Roman and Jose came to the rescue, they were their friends in highschool. They have funds, but they lack knowledge in running a business. A professional accountant suggested that Kayla, Mary, together with Roman and Jose, shall organize a new business entity. Now, they will be a corporation.
There are two types of a corporation:
A C-Corp is a corporate entity (either US or Non-US) organized in a single state through a Secretary of State.
It may do business in many states. Ownership of a corporation is in the form of stock. There is no limit to the number of shareholders that can own a C-corporation.
In addition, there is no limit on the number of classes of stock that can be issued. A corporation comes into being when its organizers file Articles of Incorporation with a state (or country in case of a foreign corporation).
Ownership of a corporation is in the form of stock. Owners are called stockholders. Stockholders hold stock certificates.
- Ultimate liability protection
- The corporation is a ‘separate entity’
- The personal assets of the shareholders will not be for corporations liability payments.
- The corporation owns assets and is liable for its debt, not the stockholders. Unless the stockholders guarantees a loan in behalf of the corporation, then the stockholder may also be liable
- There will be many owners
- You cannot withdraw the corporate’s income anytime you wish
C-corporations file Tax Form 1120 every single year.
Depends on the State Revenue Department, C-corporations might be required to file state income tax. Tax form 1120, unlike Partnerships is not just an informational return but you might have to pay taxes on a corporate level.
Shareholders on the other hand may also pay taxes if they received income out of the corporation. Either as employees of the corporation or a contractor.
- S- Corporation
S-Corporation is a US corporation that is organized in a single state.
It may do business in many states. Ownership of a corporation is in the form of stock. S-corporation can have no more than 100 shareholders and can have only one class of stock.
In addition, eligible shareholders include only individuals, certain estates, certain trusts, and certain other S-corp. A corp comes into being when its organizers files Articles of Incorporation within a state.
An S-corporation is created by filing an S-corporation election with the Internal Revenue Service (IRS).
Pros and Cons is the same as C-corp.
With some exceptions, S-corporation is not taxable on the income it earns. S-corporation should file a 1120-S Tax form.
Regardless if they received their share of income or not for that period, an S-Corporation should file a K-1 and pay for the tax due.
IV. LIMITED LIABILITY COMPANY (LLC)
Limited Liability Companies are treated like corporations but for tax purposes., an LLC may be taxed as a corporation or a partnership, and sometimes even a ‘disregarded entity’.
Disregarded Entity- an LLC that does not file a traditional LLC but will file a schedule C in the personal income tax return.
A ‘Member’ is what we call the people who organized LLC.
LLCs, although limited, may be taxed in as a Partnership (Form 1065), a c-corporation (Form 1120), or a S-corporation (Form m1120-S)
No matter how you want to formally organize your business, it pays to have good knowledge with the different business entities.
In the long run, this will help you minimize your taxes and save a lot of cost in your company. Most of the time, you have to consider the state you are in. Nevada for example does not charge state taxes, while other states may charge more.
I know that this may be a lot to take in, however, you may opt to get the services of a professional accountant to handle this matter for you.