The Law Dictionary

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Business Entity Types: Explanations and Overview

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Small businesses are the backbone of the vibrant US economy: more than half of all registered business entities have fewer than five employees. Starting your own business can be a way to monetize a hobby, meet the needs of your community, or get started in a new industry or career.

Even small operations can take advantage of many federal, state, and local benefits. Different opportunities are available for each type of business entity. Before starting a business, you should explore the options that are available to you. What type of business structure you choose can impact your organization in many ways.

Small businesses are regulated by the state or states in which they do business. Because the laws regarding business formation are different from state to state, the types of business entities authorized by each state vary. Some of the terminology is also different. Common types of business entities include:

  • Sole proprietorships
  • Partnerships and limited partnerships (LPs)
  • Limited liability companies (LLCs) and limited liability partnerships (LLPs)
  • Professional limited partnerships (PLLPs) and professional limited liability companies (PLLCs)
  • Nonprofit organizations
  • Corporations

Sole Proprietorships and Partnerships

The simplest kind of business entity is a “sole proprietorship.” In most cases, you don’t need to do anything to establish yourself as a sole proprietorship other than to start doing business. However, you may need a license or permit to provide certain types of services or sell certain types of goods.

In a sole proprietorship, you are responsible for paying taxes on your income as well as self-employment taxes, although you may be able to offset some of your tax burden by deducting allowable expenses related to the business.

Alternately, partnerships are simple business structures among two or more individuals. As in a sole proprietorship, each partner is responsible for paying individual income taxes on their portion of the profits. Partnerships can be organized as a limited partnership (LP), which has one general partner and several limited liability partners, or as a limited liability partnership (LLP) for everyone involved.

Why Form an LLC?

A limited liability company (LLC) is a very basic type of business entity that allows its owner(s) to separate the financial assets and liabilities of the business from their personal finances. An LLC can have multiple owners (called “members”), which can be individuals, corporations, or other LLCs. Members have the discretion to manage the business’s operations and distribute any profits how they choose.

Besides limiting individual liability, the primary benefits of LLCs are that they:

  • Have minimal formal requirements
  • Are easy and relatively inexpensive to start
  • Can quickly establish credibility for a new business

Most LLCs also can decide whether they wish to be treated as a pass-through business entity, an S-Corporation, or a C-Corporation for federal tax purposes. Before setting up your business as an LLC, you may wish to consult with an attorney or tax professional.

Choosing a C-Corp Business Structure

Individuals must pay taxes on their income to the federal government, most state governments, and some local governments. While there are certain deductions available, an individual’s tax burden generally correlates directly to a percentage of their income. On the other hand, a corporation can take advantage of many different deductions, accounting methods, and financial strategies to reduce its tax burden.

A corporation, or “C Corp,” is a legal business entity completely separate from any of its owners. Owners, managers, and decision-makers are generally insulated against personal liability for actions taken by the company. Corporations can issue shares, raise capital, and engage in other actions that aren’t available to LLCs or partnerships.

A corporation pays taxes as its own entity on its profits; if applicable, shareholders also pay taxes on corporate dividends. However, many corporations are eligible for tax incentives and exemptions that dramatically reduce their overall tax burden.

State and federal laws require companies to comply with many operational and record-keeping requirements. The costs to set up and maintain a corporation can be high, and there are also annual reporting requirements (and fees).

What Is an S Corp?

An S Corp is a tax classification that provides some of the advantages of an LLC and some of the benefits of a corporation. It’s not actually a different type of business entity; eligible companies can be organized as LLCs, partnerships, or closely-held corporations.

If the IRS approves a company’s request to be classified as an S Corp, the company itself will not be subject to federal taxes. Instead, its profits or losses will be reported by the individual members or shareholders.

What Is a Nonprofit Organization?

In general, the primary purpose of a nonprofit or not-for-profit business entity is to provide a collective, public, or social benefit rather than to make money for its owners. Qualified nonprofit and not-for-profit organizations are exempt from federal income taxes and may qualify for other benefits and incentives.

The rules for establishing a nonprofit or not-for-profit organization vary significantly from state to state. Most jurisdictions require a high degree of transparency in their operations, management, and accounting.

Starting a Business or Changing Your Business Structure?

Whether you’re just hanging out your shingle or you’re ready to take your small business to the next level, you’ll benefit from learning more about the many opportunities available in your area. Determine which business entity is best for you, learn the easiest way to set up your small business, browse information specific to your state, and find links to useful resources.

Disclaimer

This article contains general legal information but does not constitute professional legal advice for your particular situation. The Law Dictionary is not a law firm, and this page does not create an attorney-client or legal adviser relationship. If you have specific questions, please consult a qualified attorney licensed in your jurisdiction.

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