Best Entity Structure

A Simple Guide to Save You Time and Money 

One of the most crucial decisions is choosing the proper entity structure. This choice affects how you pay taxes, protect your assets, and even handle paperwork. 

Whether you’re just starting a side hustle, growing an existing business, or thinking about ways to protect what you’ve built, selecting the proper business structure can make your life much easier—and save you money.

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1. Sole Proprietorship

When Jane first started her lemonade stand, she kept things simple. It was just her, selling lemonade on the weekends. She didn’t have to fill out any special paperwork or register her business with an agency. [Note: If the risk of litigation is high from the start, you may want to consider opening an LLC from day one. For example, this is relevant in trade businesses such as electricians, plumbers, and tech companies.

Bookkeeping

Jane could use a simple Excel spreadsheet to track income and expenses, as every penny in the early stages matters. However, subscribing to accounting software like QuickBooks would help her better organize her records as her business grew. Jane can take advantage of the IRS code from the moment she collects her first dollar. 

Tax Deductions/Credits

For more details on tax deductions and how to maximize savings as a sole proprietor,

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Tax Reporting

• Sole proprietors report business income and expenses on Schedule C of their individual tax returns (Form 1040). 

• All profits are subject to income tax and self-employment tax. 

Pros: 

Cons: 

When Should You Consider a Sole Proprietorship?

A sole proprietorship is simple and easy to maintain if your business is small, low-risk, and pulling in less than $40K in profit. It’s great for freelancers, side hustlers, and those testing the waters before committing to a more formal structure. 

2. LLC (Limited Liability Company)

As Jane’s lemonade business grows, she forms an LLC to protect her assets. This separation of personal and business liabilities helps her feel more secure, especially as she hires a few helpers and takes on larger catering gigs.  

Bookkeeping

• Since the business has grown, Jane now needs to keep more detailed records. Using QuickBooks or a similar software becomes essential to track income and expenses more effectively. 

Tax Deductions/Credits

• Jane continues to report business income on her personal tax return but now files a Schedule C as a disregarded entity for tax purposes. 

When Should You Consider an LLC Structure?

If your business generates over $40K in profit or involves some level of risk (like a construction contractor or consultant), forming an LLC can provide personal protection without much complexity. It’s ideal for growing businesses that need a more formal structure. 

3. Partnership

Jane wasn’t in this alone for long. Her best friend, Sarah, wanted to join the lemonade empire. Together, they formed a partnership. Jane handled production, while Sarah managed marketing and operations. They split the profits evenly. 

Bookkeeping

With two people sharing the business, investing in a reliable bookkeeping system or hiring a professional to manage profit splits and expenses is essential. Tax Reporting: 

• Partnerships file Form 1065 and provide each partner with a Schedule K-1 to report their share of profits on their individual returns. 
  

Tax Deductions/Credits

While many of the same deductions from the LLC still apply (supplies, marketing, etc.), certain personal deductions become more limited in a partnership: 

And more tax strategies are limited. This is why having proactive conversations with your tax advisor is critical!  

Tax Reporting

• Partnerships file Form 1065 and provide each partner with a Schedule K-1 to report their share of profits on their individual returns. 

Pros

Cons 

When Should You  Consider a Partnership Structure?

A partnership is ideal if you and a partner bring different strengths to the table and want to grow the business together. Just make sure to formalize the partnership with a written agreement to avoid future disputes. It is highly recommended that an attorney set this up correctly. 

4. S-Corp (S Corporation) 

Assuming Jane never entered into a partnership with her best friend Sarah, Jane's lemonade business was thriving. With multiple locations and a steady revenue stream, she wanted to save on taxes. She was profiting more than $60,000 in her business. Her Tax Advisor recommended it was time to switch to an S-Corp; Jane was able to take a salary and avoid paying self-employment taxes on her entire profit. 

Bookkeeping

• With the increased complexity, Jane hires a bookkeeping firm to categorize income and expenses, handle payroll, and ensure that all business records are kept accurately for IRS compliance. 

Tax Deductions/Credits

Tax Reporting

• Jane now files an 1120S (S-Corp Return), and her salary and business distributions are reported on her personal tax return. She’ll also need to issue herself a W-2 for her salary. Additionally, the S-Corp will issue a K-1 for the remaining profits/losses. 

Pros

Cons

When should you consider an S-Corp structure?

An S-Corp is ideal for businesses making over $60K in profit, where owners want to save on self-employment taxes. It’s perfect for owners who are ready to formalize operations, hire employees, and scale up. But keep in mind that you’ll need to handle payroll and corporate formalities. 

5. C-Corp (C Corporation)

Jane's lemonade empire had grown so large that she decided to raise funds from investors and offer stock to her employees. She also contemplated selling the business when the right opportunity arose. To achieve this, she restructured her business into a C-Corp, enabling her to issue stock and appeal to more serious investors. 

Bookkeeping

• At this stage, Jane works with a professional accounting firm to manage the C-Corp’s financials, ensuring payroll, inventory, and expenses are all categorized and managed properly. 

Tax Deductions/Credits

Tax Reporting 

• The business now files a Form 1120 (C-Corp Return) and pays corporate income tax on its profits. Jane is taxed separately on any dividends she receives from the business. 

Pros

Cons: 

When Should You Consider a C-Corp Structure?

A C-Corp is perfect for large businesses planning to grow significantly, raise investor capital, or go public. It’s also the best choice if you want to offer stock options to employees. However, the double taxation and complex compliance requirements make it less ideal for small businesses.

Here’s a summary recap to help you decide:

By recognizing the advantages and disadvantages of each business structure, you can make an informed decision that aligns with your goals, risk tolerance, and financial aspirations. Every business is unique, so select the structure that best suits your vision for growth and success. 

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Disclaimer

The information provided is for general purposes and does not constitute tax, legal, or financial advice. Tax situations vary, and we recommend consulting with a qualified tax professional or attorney before taking any action. Spark Tax Services LLC is not responsible for any errors or the outcomes from using this information, and tax laws may change.