What is a business entity?

What Is a Business Entity?

A business entity is an organization formed to carry on business. The type of business entity that affects the business is taxed and its liability exposure.

Learn more about how business entities work, how you can form, and what types of business entities exist.

Definition and Example of Business Entity

Business entity categories refer to the type or structure of a business, not what it does. How it is structured affects how taxes are paid and how liabilities are determined. Business entities are created at the state level, often by filing documents with a state agency such as the secretary of state.

  • Alternate Name:  Business Structure

A freelancer can form a limited liability company (LLC) to protect their personal assets from liabilities incurred by their business. 1  They will do that by filing paperwork with the appropriate state agency and paying a small fee in most states.

How Business Organizations Work

Choosing a business entity is one of the first steps a business must take. It affects which tax forms you file and what happens if your business is sued. Many business structures offer protection for your personal assets. Your business assets may be at risk if you are sued, but your personal assets may not be.

If necessary, new business entities are formed by filing paperwork with your state and paying any required fees. The best type of business entity to choose depends on the type and nature of your business and the number of owners. It’s one of the most important decisions business owners can make, so it’s best to consult tax and legal professionals for advice specific to your business.

Types of Business Organizations

States recognize many business entities, but most business owners will choose one of five: corporations, general partnerships, limited liability companies, limited liability partnerships, or sole proprietorships.

sole proprietorship

A sole proprietorship is an unincorporated business with one owner or two owners who are married. This is the default entity if you start a business and are a sole proprietor. You don’t need to register it with your state, but you may need to obtain a business license or permit depending on the type of business you operate.

Freelancers and consultants are often sole proprietors. You file one tax return with this business entity instead of separate business and personal tax returns. 2  Your personal assets may be at risk from this type of structure if your business is sued.

General partnership

A general partnership is an unincorporated business with two or more owners. All partners manage the business and share the profits. It is the default form of ownership for businesses with multiple owners. As with a sole proprietorship, your personal assets may be at risk if your business is sued, but all partners share that risk.

Limited partnership

A limited partnership is a registered business entity. In this entity you have two types of partners: general partners, who actively manage the business and assume liability, and limited partners, who act only as investors without managing the business, which limits their liability and their tax burden.

Corporations

A corporation is a separate, legal entity that separates your personal and business assets. It consists of shareholders, board of directors and officers. Setting up a corporation is more complicated than setting up a sole proprietorship or partnership. There is more paperwork, and the fees are higher. A drawback is that profits may be taxed twice: once when profits are made, and once when dividends are paid.

An S corporation is a special type of corporation that offers pass-through taxation. Profits pass through to the owners’ personal income without being subject to corporate tax, thus avoiding double taxation. S corporations cannot have more than 100 shareholders. All shareholders must be US citizens. 

Limited Liability Companies (LLCs)

A limited liability company (LLC) provides liability protection. Easier to set up than a corporation. You can choose whether to treat it as a corporation or as a pass-through entity for tax purposes. LLCs can have one owner (known as “members”) or many, so they are a useful alternative to sole proprietorships for freelancers and other individual business owners.

What is a business entity?

Leave a Reply

Your email address will not be published.

Scroll to top