Starting a Business? Get Familiar With the 3 Most Common Entity Types. Knowing how to structure your company before you move forward is the key to success.
By Joseph Ferriolo Edited by Amanda Breen
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Starting a business is one of the most exhilarating experiences you can have. After all, you're the beating heart and soul of your new company, and its success is your success.
But the will to form and own a business doesn't automatically equip you with all the information you need to make your dreams a reality. You'll have a full list of things to research and understand on the way to financial independence.
One of those research items is understanding the kinds of companies out there and then asking yourself, "What kind of company is right for me?" Answering this question takes some thought about what you want to accomplish with your company, what you'll provide and who you plan to employ.
Related: 7 Mistakes to Avoid When Choosing Your Business Entity
Sole proprietorships
If you're a crafter or an artist creating something unique your own or a freelance designer, editor, writer or other service provider who works alone for different clients as needed, this is most likely the kind of company you'll be starting (at least until you decide to expand).
Doing business as a sole proprietorship is simple and easy — in almost all instances, your taxes and other business accounts are merged with your personal identity, and there are no special forms to fill out to get started. In some instances, you'll want to lay the groundwork for a larger company by setting things up in a slightly more comprehensive way. Read on to learn about the most common way sole proprietors take the next step: an LLC.
LLCs
A Limited Liability Company, or LLC, does just that: It limits your personal liability when it comes to business accounts and dealings. When you form an LLC, whether alone or with partners, you separate your business and personal finances, meaning you are not personally liable for the company's debts and liabilities.
An LLC is similar to a corporation, but it allows its income to flow directly from the company to the individual owners. And those owners then pay their personal income tax rate on the profits, rather than a corporate rate. An LLC will likely require an Employer Identification Number (EIN). An LLC is usually the most common business entity formed.
Related: How to Set Up and Maintain Your Business Entity
Corporations
A corporation stands apart from its owners in every way, from taxes to liabilities and debts. Most corporations tend to be larger companies, and shareholders own them with a board of directors tasked with making decisions. However, in most states, you only need one person to incorporate your business. Different types of corporations can be formed, such as a C or S Corp, depending on the number of shareholders and other factors. This is the most complex kind of common business formation, but it can be the right fit if you have a large and involved company structure in mind.
Choosing the right kind of business formation can be easy in the case of a sole proprietor or more difficult as your vision for your company becomes more complex.
Okay, but what is an EIN, and how do I get one?
"EIN" stands for "Employer Identification Number," and the IRS issues it. It's a free service provided online.
If you are a sole proprietor without employees or partners, the IRS says an EIN is not necessary for your business. However, if your company is a corporation or LLC, you'll need to apply for an EIN, even if you don't have employees right away. You'll also need an employer-identification number if you file employment and excise alcohol, tobacco and firearms (ATF) tax returns. In addition, if you withhold taxes on income paid to a resident alien or are involved with the following kinds of agencies, you'll need to apply for an EIN:
- Trusts (except for certain grantor-owned revocable trusts), IRAs, exempt-organization businesses.
- Estates.
- Real-estate mortgage investment conduits.
- Non-profit organizations.
- Farmers' cooperatives.
- Plan administrators.
An EIN is also required if you have something called a Keogh plan. This is a special kind of tax-deferred pension plan that is made available to those who are self-employed unincorporated. You must have self-employment income to set up a Keogh plan. Keogh plans are also often referred to as HR-10s or qualified retirement plans.
When starting a business, you're eligible to apply for an EIN online if your principal business is in the United States or a U.S. territory. The application must be completed in one sitting, and you'll need a valid taxpayer ID number or Social Security number. Thankfully, the application is a simple, interview-style series of questions, and you'll receive your EIN immediately upon completing it.
Related: 5 Tips for Structuring Your New Business Like a Pro
