How to Choose an Entity for your Small Business

Hi there! If you are a new business owner, you are likely stumped about how to structure your business venture. You have so many options for entity structure and you can use the information from this blog to help you get started.

Step 1: Determine your type of business activity

First, you want to understand if you business activity falls into the “active” or “passive” income category. As different structures may be more or less beneficial depending on the category. If you have a rental property you are looking to place in an entity, your rental activity will likely fall into the passive activity space. If you are providing services or selling products to customers, your business activity will likely be consider active income. The important difference between active and passive business activities is that active income is subject to self-employment tax and passive income is not.

Step 2: Understand the entity options

LLCs are the most common entity structure because they are flexible in the way they can be taxed. An LLC can be treated in several different ways for tax purposes.

An LLC can be set up as a sole-proprietor LLC (AKA a single member LLC), a partnership, or a corporation for tax purposes. In general, single member and partnership LLCs are the best structure for passive activities such as owning rental properties.

A corporation can be set up as a traditional corporation or with an additional election can be treated as an S-Corporation for tax purposes. In many cases, an S-Corporation structure can be the most beneficial for small businesses that fall in the active income category. However, corporations are typically never a good choice for rental real estate.

Step 3: Find a CPA & attorney

Choosing the right entity structure can be complex and everyone’s individual situation is different. It is best to work with both a CPA and attorney to ensure you set up the right entity structure for your business and individual tax situation. Setting up the wrong structure for your business activities can be a costly mistake and it is often much more costly to correct issues than it is to set up the entities correctly from the beginning of your business.

Contact us to find out more about how we can help you with entity structuring!