Knowing What Counts Podcast

The Business Entity Blueprint: How Your Business Structure Shapes Everything

• Tim Provost, CPA • Episode 11

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Entity Essentials: Choosing the Right Structure for Your Business 

Selecting the right business entity structure might be the most consequential decision you'll make as an entrepreneur. Tax implications, liability protection, paperwork requirements, and future growth potential all hinge on this critical choice.

In this comprehensive guide, MP CPAs Tax Senior Associate Katelyn Henderson walks us through the maze of business entity options with clarity and expertise. We begin by exploring essential first steps for any new business venture, from crafting a solid business plan to securing financing and navigating registration requirements. Then we dive deep into the five main legal structures available to business owners—sole proprietorships, partnerships, LLCs, S-corporations, and C-corporations—examining their distinct advantages and potential drawbacks.

For sole proprietors, simplicity and complete control come with unlimited personal liability risk. Partnerships offer increased capital potential but similar liability exposure. LLCs provide that crucial liability shield with flexible distribution options, while S-corporations eliminate self-employment tax but require reasonable compensation through W-2 wages. C-corporations maximize protection and capital-raising potential but face the most regulatory hurdles.

Whether you're launching a new venture or reconsidering your current business structure, this episode provides the knowledge framework you need to make informed decisions that align with both your immediate needs and long-term vision. Connect with our team of experts at MP CPAs to develop a customized strategy for your business's success.

To learn more about MP CPAs visit:
https://thempgroupcpa.com/
MP CPAs
413-739-1800

Speaker 1:

Welcome to the Knowing what Counts podcast, the place where expert guidance meets smart financial decisions. Whether you're a high net worth individual or a thriving business, the experts at MPCPAs are here to help you protect and optimize your wealth. Let's get started, because success begins with Knowing what Counts. Because success begins with knowing what counts.

Speaker 2:

Your choice of business entity can have a huge impact on your tax liability and growth potential. In this episode of Knowing what Counts, we break down the pros and cons of each structure and help you understand the long-term financial implications of your decision. Welcome back everyone. I'm Sophia Yvette, co-host slash producer, back in the studio with Caitlin Henderson, tax senior associate at MPCPAs. Caitlin, how's it going today? I'm doing great. How are you? I'm also doing great. So, caitlin, introduce yourself to our listeners. Tell them a little bit about yourself.

Speaker 3:

Yeah, so as you mentioned, I'm a tax senior here at MPCPAs. I've been with the firm for about five years now and I've gotten to work closely with both clients and other managers and partners in the firm on various different types of tax returns and side projects anything related to tax work.

Speaker 2:

Thank you for sharing that with us, caitlin. Let's go ahead and get into it a bit more. So everyone listening wants to know which entity is right for you and how do you decode business structure decisions. Now getting into the first question here what are the first steps to think about when wanting to start a business?

Speaker 3:

So, obviously, starting a business comes with a lot of questions, right? There's a lot of things to think about and it can sometimes feel overwhelming at first. So here are like a few helpful hints that could help you when you're getting started. First thing would be to write a business plan. It's like a description of your company, includes a market analysis, a marketing plan, and if you are looking for financing or investors, they might look for something like this that kind of lays out the ins and outs of how your business will work.

Speaker 3:

Branching off of that financing your business something to think about. Where will you get the money to start your business? It could be bank loans, sba loans or maybe something private, determining the legal structure of your business, which is what we're going to get into later in this podcast. There's a bunch of different types of things that may work better for you. Some other things to think about would be maybe registering a business name or a doing business as name, getting a tax ID number and registering for state and local taxes, depending on where your business is going to be located. There is different requirements for each state, so it's important to look into that as well as depending on what your business is going to be, you may need certain licenses or permits, so important to consider that, and if your business is going to have employees, you want to make sure you understand your responsibilities as an employer before getting started.

Speaker 2:

Now, what are the main types of legal structures to think about?

Speaker 3:

All right. So we're going to go through five different structures here that you can consider. So the first would be a sole proprietorship. That is, when your business is just you by yourself, no one else involved, there's no separate legal entity and you may operate under a doing business as name. There's a partnership, which is a legal structure with two or more people. There's an LLC, which is a legal entity that's formed by filing and articles of organization with the state you're located in and it is required to have an operating agreement.

Speaker 3:

There's an S-corporation, which is a corporation that elects to be treated that way through the IRS Form 2553. And what that does is it puts a limit on the number of shareholders you can have at 100, where in a regular corporation you can have unlimited shareholders. Where in a regular corporation you can have unlimited shareholders and your shareholders in an S corporation are limited to US resident individuals, trusts and estates, and you can only have one class of stock in an S corporation. And then, finally, just a corporation. A C corp is a separate business entity that's organized under state laws for whatever state you're located in. It is completely distinct from all its owners and it is run by a board of directors officers and requires business registration in your state.

Speaker 2:

Now, what are the advantages and disadvantages of some of these entity structures?

Speaker 3:

So each one has its pros and cons, so we'll start with the first one. We talked about a sole proprietorship. Some pros here are they're very easy to implement, they're low cost and you have full control over your decision making. Since it's only you, we like to recommend to clients forming a sole proprietorship that they get a separate tax ID and bank account just to keep your business related things separate from your personal, but it's not required. Disadvantage to a sole proprietorship is that there is high risk for legal liability, meaning that since it's just you on your own and there's no separate entity, everything you own is subject to that liability. Moving on to a partnership, some pros here they're relatively easy to establish and they're more flexible in management and operations compared to corporations. When you have a partnership, you naturally have increased capital available to you when more than one person is investing compared to a sole proprietorship, and partners can share the workload and responsibility of the business, which is definitely an advantage. Some cons here would be there is unlimited liability in a partnership, meaning that each partner is personally liable for the debts and obligations of the business, and there is also a risk that if one partner decides they don't want to be involved in the business anymore. The partnership could dissolve and that could disrupt your business.

Speaker 3:

Llcs are very similar to partnerships in their advantages and disadvantages. One thing that's a little more appealing for an LLC is that there is limited liability protection from the partner's personal assets unless they make a personal guarantee and LLCs can be set up with only one owner. And there's also more flexibility in LLCs with distributions and allocating income or loss at disproportionate amounts. Some cons here they can be more expensive to set up than the previous entities we talked about, and you can't pay yourself through a W-2 in an LLC, which means you don't get withholding on your income. This can be surprising to people at first when they're setting up an LLC, so we always like to point it out In an S corporation.

Speaker 3:

Some advantages here are that they provide personal liability protection to the shareholders and, similar to the LLCs can be set up with just one owner. Some cons since it is its own separate entity, it can be expensive to set up. There's a lot that goes into it. There's restrictions on the number and type of shareholders, as we discussed earlier. You are required to pay reasonable compensation, which means you would get paid through a w-2 here, but that can come with more filings, more taxes, things like that, and there is limited flexibility in distributions out of an S-Corp, meaning that all income and loss needs to be allocated pro rata by ownership percentage.

Speaker 3:

And last thing here that could be a bit of a disadvantage is that more regulations and formalities come with an S-Corp. Things like annual filings, board meetings, issuing stock. Those are all things that are required of an S-Corp and are important to think about. And then, lastly, for a corporation, some pros here. They again provide personal liability protection to the shareholders and there is a limited risk of loss, because you can only lose what you invested in a corporation. A corporation itself can borrow money without a personal guarantee and can generate its funds through sale of stock. Some cons here would be very similar to the ones we discussed for S-Corps in terms of regulations and formalities that come with them.

Speaker 2:

Wow. Now what are some of the other tax implications for these structures?

Speaker 3:

Yep, so each entity has different tax filing requirements. A sole proprietorship actually doesn't have its own separate filing. So if you decided to go that route, all your income and loss from your business would be reported through a Schedule C on your personal tax return. And it is important to note that in this type of entity all of your income would be subject to self-employment tax. Partnerships and LLCs are pretty similar for tax purposes. The income still flows to your individual tax return and the owners are taxed on all the income from these entities, regardless of any distributions of money you take out of the business.

Speaker 3:

Employees through these types of entities are also paid by guaranteed payment, which is subject to self-employment tax rather than through a W-2. And it's important to note here that there still may be other tax filing forms if you have employees in a partnership or LLC. That can vary depending on how you've set things up. S-corporations provide the advantage compared to a regular corporation that they are not subject to double taxation and they do not create self-employment tax. We mentioned this briefly before that in an S-corporation you pay yourself and employees through a W-2, so you get withholding on your wages, which is an advantage for an individual and For corporations. The important thing to note here is that there is something called 1202 stock where there is potential for a 100% gain exclusion upon sale of the entity. We do have a whole separate podcast on this that you can listen to to get more details on that.

Speaker 2:

Now, which structure is the best?

Speaker 3:

So this is a question we get a lot from our clients when they're looking to set something up, and the answer really is it just depends on the client and their type of business. Something that's always important to consider is that there is a legal side of things and a tax side of things, and those may not always go in the same direction. So it's important to communicate with your CPA, communicate with, maybe, an attorney or something like that, and figure out what works best for you. So maybe what is your risk tolerance and what is your desire to have more tax benefits? That could alter your decision.

Speaker 3:

Some businesses may have more litigious risk than others, depending on the activity and the business type, and so they may need an entity that gives them more protection. And then it's also important to consider what are your long-term goals for the business. Do you plan to sell the business once it takes off? That would have different tax implications and upon exiting, that could depend on the type of entity you have, how that gets treated. So that's important to consider. And then, finally, do you need investors and the ability to raise capital? Then you might want to go with a corporation when setting up your business, so that you have the ability to do that. So there's a lot of different ways to answer that question, and it's more so a conversation that you just have between advisors and clients to figure out what suits them best advisors and clients to figure out what suits them best.

Speaker 2:

Now, what are some pitfalls?

Speaker 3:

What are some of the pitfalls a lot of new business owners tend to fall into. There can be a few different things, so we want to highlight some things here that maybe you could avoid if we let you know them ahead of time. So first thing would be not planning ahead. You want to make sure you have that business plan that we discussed at the beginning. Underestimating costs could go hand in hand with that. If you don't have enough capital raised or financing to support your business as it's taking off, that can be a pitfall. Your business as it's taking off that can be a pitfall.

Speaker 3:

Not having good record keeping and financial management Maybe something to consider is taking a bookkeeping course or hiring a bookkeeper, if that suits your business better. Not being knowledgeable on financial statements and basic accounting it's important, at the very least, to just have a basic understanding of what the financial statements might look like. So maybe that is taking an accounting course or looking at some sort of education online that could be provided to you. And then one thing that everyone should do or should not do, is try to do everything on their own. You want to find a good attorney, find a good accountant and maybe even a financial advisor that can help you along the way when you're starting up your business well.

Speaker 2:

thank you so much for those helpful insights today, cait. We'll catch you in the next episode. Have a fantastic rest of your day. Thanks, you too.

Speaker 1:

Thanks for listening to the Knowing what Counts podcast. Ready to optimize your wealth and protect your future, visit thempgroupscpacom or call 413-739-1800 to connect with our team of experts. Remember, success is about knowing what counts.