A business entity refers to a type of business or the legal structure of that company. It does not refer to what that business does, the product or service it sells, or its industry.
As you develop your business, you may decide to change entity types depending on your plans for growth. Learn more about what a business entity means and how you can choose the right one below.
What Are the Different Business Entities?
A business entity structure varies by the size of the company (in some cases) and how it operates for tax purposes. The most used businesses entities include:
- Sole Proprietorship: A business run by a single person without shareholders or employees.
- Partnership: A business run with 2 or more owners, where all owners manage the company and share the profits.
- Limited Liability Company (LLC): A company that offers liability protection to its owners. This entity is often used by individuals to differentiate their personal and professional accounts.
- Corporation: A professional entity that has shareholders, a board of directors, officers, and (often) employees. This designation tends to be the largest option.
Additional entity options, like S corporations and C corporations, are also distinguished for tax purposes. However, the 4 entities listed above cover the majority of companies.
What Are Business Entities Used For?
The Internal Revenue Service (IRS) differentiates business entities for tax purposes. They ensure that business owners pay the right amount of taxes or that some people don’t get double-taxed. For example, a sole proprietor running an LLC would only need to pay personal taxes because the LLC is a pass-through entity.
Can You Change Your Business Entity?
In some cases, yes. As your business structure changes, you can adjust your status to become a different entity. For example, a sole proprietor can become a partnership if that individual finds someone to work with. They can also file for LLC status if they want additional protection.
You can change your business entity status on your tax forms, but most states have a formal process to become an LLC or corporation. There are fees for forming LLCs and paperwork for some corporations. You will also have to submit annual reports to your state government if you operate an LLC or a corporation.
Are Some Business Entities Better Than Others?
The status that you choose for your business is based on what is right for you at the time. One status is not better than the other when reviewed as a whole. However, there will likely be 1 or 2 entity options that stand out as you decide which to choose. When deciding on the best entity for your business, consider your current size and structure, as well as your growth plans and tax strategy.
Knowing your options for the different business entities can help you launch your company with the right status for your tax needs. You can file correctly and potentially save money. As you launch your business, make sure you have organized bookkeeping and an accounting plan for your taxes. Consider using a free service like Sunrise to keep your records in order. Our tools are here to help you.