You’re starting a small business! Congrats! After picking a name and a concept, one of the most crucial things you can do to set your business up for success is to pick a business entity type or structure that best benefits you and your company. Each entity type has different tax and legal liability obligations so it’s important to know what exactly you’re getting into. It is always recommended to meet with your accountant prior to registering your business with the Arizona Corporate Commission and IRS to ensure you are making the most informed decision. You can setup a consultation here with the My Accountant Bookkeeping and Tax Service team. In Arizona, there are 12 different entities that you can possibly choose from when starting your business. However, majority of business owners choose one of these 4 more common entities:
- Sole Proprietorship: As the name suggests, a sole proprietorship is owned by one sole individual. In the state of Arizona, you technically don’t even need to register with the state if you choose to use your name and social security number for the Tax ID. An example of this may be a cosmetologist with their own studio who uses their name to do business. You can also have a sole proprietorship with a trade name, which you should then consider registering with the state to ensure your name can’t be used by others.
- Legal Liability: With a sole proprietorship, the business owner is 100% responsible and liable for any legal obligations. That means you as the owner may have to pay out of pocket in the event you were sued. You may even have to sell your assets to do so! The business won’t protect your assets. An example may be someone being injured while you were conducting business. You as the sole proprietor can be held personally responsible.
- Tax Liability: A sole proprietorship business owner reports all of the businesses profits and losses on their individual tax return. Because sole proprietorships are not taxed separately, the business owner would report this information on their own tax return by completing a Schedule C form. This is essentially a profit and loss statement for the government to review.
- Partnership: This entity type is a good option for any business with two or more owners but it works similarly to the sole proprietorship. You don’t have to have any formal documentation or business agreements, however you must follow any applicable licensing and tax requirements. That means getting an EIN number from the IRS and any other licensing necessary to run your business legally.
- Legal Liability: Depending on the structure of your partnership (general, limited, limited liability, etc) will depend on who is held liable. Some partnerships allow the liability to be shared equally among the owners and others have one partner be held more liable than the others. With more liability typically comes more control of the overall business.
- Tax Liability: Similar to a sole proprietorship, in Arizona, a partnership business is not taxed separately from the individual. Each partner is held accountable to report their profits and losses on their own individual tax return. Partnership entities also must file a 1065 form which is similar to a profit and loss statement.
- Corporation: A corporation is considered its own entity. Unlike a sole proprietorship or partnership, a corporation and its owners are not considered one. Because it is considered its own entity, owners are not held personally liable making this option appealing to some. There are many different corporation types but the most common are an S corp and a C corp. The main difference between the two are how they are taxed. Corporations also allow for an easy transition if an owner (also considered shareholder) leaves the company causing little disturbance to the business.
- Legal Liability: A corporation is its own entity so the corporation is held legally liable rather than the shareholder/owner. That means if you are sued and the business has to pay or settle, you as the owner are not responsible for coming up with the funds by selling your own investments or assets.
- Tax Liability: Being its own entity means a corporation is required to file its own taxes in addition to the owners individual return. Depending on the structure of your corporation will depend on how you are taxed. You may also be subject to state, sales, and employee taxes.
- Limited Liability Company (LLC): A LLC is often a happy medium between a partnership and a corporation. It is typically simpler to setup but allows the owner some protection from liability. To remain compliant and ensure the business remains legally liable, you must have an EIN number and open a separate bank account for the business. LLCs also allow for the owners to decide if they complete a tax return like a corporation.
- Legal Liability: Similar to a corporation, the entity is held liable in the case you were to be sued. This means you, the owner, will not have to sell your personal assets to front the money.
- Tax Liability: A benefit of an LLC is that they can pay taxes as a “pass-through” entity would (such as a sole proprietorship or partnership) or they can choose to pay taxes as a corporation would. It is important to talk to your accountant to determine the best way to file for your business.
Having a basic understanding of these common business entities will help give you some tools when making your decision and asking questions to your accountant. Although, you can technically go through a process to change your entity type down the road, it is very time consuming and sometimes costly. Setup a meeting with the My Accountant Bookkeeping and Tax Service team before you open your business to ensure you are setting yourself up for years of success.