What are the different business types for your business

Different business types
(Last Updated On: October 6, 2017)

Understand there are business entities, there are taxable entities, and there are exceptions


Of course, you’re aware there are different business types. Although it pays to work with legal and accounting professionals when choosing your business type, by understanding the big picture, you will be in a much better position to strategize with your business consultants. What are the different business types, and what are the benefits and problems with each? Here’s a rundown of the various business entities, the tax entity options, an analysis of the considerations in choosing the correct entity and some summary recommendations.


Different Business type exists to provide tax and operating benefits in conducting various commercial activities.


There are four primary business entities that are recognized by state governments, as follows:


  • Sole proprietorships,
  • Partnerships,
  • Corporations, and
  • Limited Liability Companies (“LLC”)


Taxable entities relate to which specific tax code a business entity is either required to utilize or, if allowed, elects to use.


Taxable entities may or may not be the same as the business type and include the following:


  • Sole proprietorships – Any individual who starts a business enterprise without filing for recognization as a corporation or LLC, may do so as a Sole Proprietorship.
    • Generally, these individuals would file what is known as an “Assumed Name” or “Doing Business As” or “DBA” notification, usually with the county to which the business resides.
    • The associated business return is a Schedule C  which is included on the personal tax return (Form 1040) and will use the individuals Social Security Number (“SSN”.)


  • Partnerships – Two or more individuals or entities, can also begin a business as a Partnership.
    • Generally, the partners would choose a business name,
    • file an Assumed Name or DBA,
    • Draft and sign a Partnership Agreement,
    • obtain any necessary business licenses, and
    • file for a Federal Employee Identification Number (“EIN”.)
    • The business return is a Form 1065 which uses a Partnership Schedule K-1 to “pass through” the partner’s share of income, deductions, credits, and other items into the individual’s personal tax return, Form 1040.


  • Corporations – Any person(s) and certain entities, can file with their respective Secretary of State to operate as a Corporation.
    • Generally, the shareholders will file for name approval with the Secretary of State,
    • File a Certificate of Formation with the Secretary of State,
    • Appoint a Registered Agent,
    • Draft and sign Articles of Incorporation and Corporate Bylaws,
    • Appoint Directors and Issue Stock, and
    • File for a Federal Employee Identification Number (“EIN”) as well as obtain other necessary business licenses.
    • The business return is a Form 1120 which is a separate taxable entity.


  • Sub Chapter S Corporations – a regular Corporation or LLC can elect to be “taxed” as a S Corporation.
    • The Sub Chapter S Election allows for income to be taxed at the shareholder level vs. taxed at the corporate level.
    • The business entity would file a Form 1120S. The S Corporation uses an S Corporation Schedule K-1 to “pass through” the Shareholder’s share of income, deductions, and credits to the individual’s personal tax return, Form 1040.


  • Limited Liability Companies – Any person can elect to Operate as a Limited Liability Company.
    • Generally, its “Members,” will choose a name and file a Certificate of Formation with the Secretary of State,
    • Appoint a Registered Agent,
    • Prepare and sign an Operating Agreement, and
    • File for a Federal Employee Identification Number (“EIN”) as well as obtain other necessary business licenses.
    • For Federal Tax purposes, LLC’s can elect (by checking a box) to be taxed as a:
      • Sole proprietorship,
      • Partnership,
      • Corporation or,
      • a Sub-S Corporation.
        • Once elected, the business return and taxation are the same as the four tax entities described above.
        • By default, single member LLCs are taxed as sole proprietorships and multiple member LLCs are taxed as partnerships. You elect not to have the default treatment.


Exceptions and additions to the above legal and tax business types.


There are special provisions related, for example, Non-Profit Corporation, Farms, Banks, Insurance Companies, and Real Estate Investment Trusts (“REITs”) etc.


Additionally, partnerships can be either General, Limited or Limited Liability Partnerships (“LPs and LLPs.”)


  • The General Partnership shares management, liability, and profits and losses based on partnership contributions and agreement.
  • Limited Partnerships are formed with General Partners, who manage and retain the liability, and limited partners who contribute the capital, do not manage and limit their liability.
  • Limited Liability Partnerships retain the tax advantages of general partnerships but offer some personal liability protection.


Finally, Professional Corporations are used by licensed professionals – doctors, attorneys, CPAs etc., to allow the tax benefits of a corporation and some liability protection, but protect the rights of patients and clients against malpractice. States vary as to limits and the extent of protections afforded PCs.


Considerations in selecting your business and tax business type


Now that we understand the business entities available and the various tax options, here are the considerations you should evaluate in making your business and tax selections.




  • Sole Proprietorships require nothing more than filing a Doing Business As (“DBA”) form. You need to check what your requirement are in your location. Some cities have business license requirement which again, you can search on the Internet.


  • Partnerships also, generally require only a DBA and a written partnership agreement.


  • LPs, LLPs, Corporations, and LLCs, require registration with your Secretary of State.
    • They will also require written documents – Partnership Agreements, Articles of Incorporation and Bylaws for Corporations and an Operating Agreement for LLCs. Fees vary by state but usually, LLCs are less expensive.


  • Bonus Tip: It is possible to run multiple entities under a single Corporation or LLC simply by filing DBAs.


Ongoing Costs and Formalities


  • Corporations since they are considered a separate entity, require annual filing fees and formalities such as minutes. Failure to do the required filings and minutes can allow the piercing of your corporate veil and may invalidate the corporation, which in turn can expose shareholders to personal liability.


  • All other business entities require little to no annual fees or formalities.
    • It’s important to understand that LLCs who elect Corporate or S Corporate tax treatment, do not file minutes. This is because the legal entity is the LLC and LLC’s do not have the ongoing formalities that corporations require, regardless of the tax entity that is elected.


Liability Exposure and Protections


  • Corporations and LLCs are treated as separate legal entities and therefore creditors are unable to look to shareholders and members personally for payment. This liability protection, however, is moot when the shareholders or members personally sign for the loans of the corporation or LLC.


  • All other business structures, except Limited Partners in an LP, are personally liable to the creditors of the business entity.


Capital Raising – Equity and Debt


  • All business entities can borrow funds;
    • lending agencies will lend to owners personally in Sole Proprietorships and Partnerships.
    • Corporations and LLC are considered separate entities and can borrow funds in the name of the Corporation or LLC however; banks will usually require that the shareholders and members co-sign the loan and will review their financial capacity in order to make any lending decisions.


  • Limited Partnerships raise capital through the sale of limited partnership interests.


  • Corporations and LLC raise capital through the sale of stock and membership interests.
    • Corporations facilitate significant capital raising potential.




  • Sole Proprietorships, Partnerships, and S Corporations are all taxed at the individual owner’s level.


  • Corporations pay a Federal tax of 15-35% which, with state taxes, average approximately 38.9%.
    • Since dividends are not deductible to the corporation, there is effectively a double tax on dividends – once at the corporate level and then at the shareholder level.


Audit Exposure


The audit exposure risk from 2014 by tax entity, is as follows:

  • Sole Proprietorships
    • Gross Receipts of $25,000 – $100,000 – 1.9%
    • Greater than $100,000 – 2.3%


  • Corporations
    • Total assets less than $10 million – 1%
    • Assets between $1 and $5 million – 1.2%
    • Assets between $5 and $10 million – 1.9%


  • S Corporations, Partnership
    • change of audit – 0.04%


Summary and recommendations of different business types


  • Sole proprietorships generally, do not make sense except for very limited business activity. The simplicity of formation is more than offset by the lack of liability protection, higher audit exposure, and reduced tax benefits.


  • Partnerships are useful for specific purposes such as Family estate planning or Real Estate investing where the management and liability of the general partners are distinct from the limited partners who provide the capital. They are also useful in situations where revenue is split differently from ownership. In other words, for specific and guided tax and investment planning purposes.


  • Corporations are preferable for large publicly held companies. The high tax rate and double taxation on dividends end up driving operations offshore, but it is an ideal vehicle for capital raising efforts. Additionally, it has many employee fringe benefit options. The costs of formation, operations, taxes and general operational planning require an entity with substantial revenues.


  • LLCs and Corporations, with S Elections, are the sweet spots for many Internet businesses. Even more, the LLC with an S Election is usually the preferred way to operate an Internet-related entrepreneur business.
    • This applies because of the following reasons:
      • Formation and operation of an LLC are inexpensive and minimal.
      • After the Operating Agreement, no annual minutes or other formalities are required.
      • The LLC is a separate legal entity with all the liability protection afforded an LLC.
      • The audit risk exposure of an LLC is almost de minimus.
      • The tax benefits afforded an LLC with a Sub S Election are compelling and include most of the fringe benefits provided a Corporation.
      • Revenue distributions to members can be a combination of compensation and dividends. Additionally, dividends are free from FICA and Medicare taxes. Finally, there is no double tax problem since all net income is “passed-through” to the shareholders.


There are other business and tax planning considerations, which may even enhance the choice of an LLC with an S Election but these are beyond the scope of this post. Let me say, however, that it will be important to explore expense deductibility including an accountable plan and the various available retirement options when you’re ready to pursue your business and tax entity.


Give us your thoughts on what business and tax entity you use and why.