Questions to Ask When Choosing a Business Entity
For anyone about to start a business, or to put a side business on a formal footing, who has not settled whether it should be a sole proprietorship, a partnership, an LLC, an S corporation or a C corporation, and for the attorney or CPA taking them through it. The questions follow the order the decision usually takes: owners and plans, liability, taxes and pay, investors and co-owners, state fees and paperwork, and what a change would cost later. The terms are those of the United States and the answers shift from state to state, so each one is something to put to a local adviser.
The questions
Each question, and why to ask it
Owners and plans
Who will own the business on day one, and is anyone likely to join in the next two years?
Why ask it
A single owner can pick anything except a partnership, while two or more rule out a sole proprietorship and make a written agreement between them the first job. Count the people who might come in later as well, a spouse, a key employee, a silent backer, because a structure picked for one person can fit three badly.
Is every owner an individual, or will a company, a trust or someone living abroad hold a share?
Why ask it
S corporation status in the United States restricts who may be a shareholder, so an owner that is another company, certain kinds of trust, or a person who is neither a citizen nor a resident can take that option off the table. List every intended owner by kind before anyone recommends a structure.
Will all the owners work in the business, or will some only put in money?
Why ask it
Working owners tend to want a paycheck and a say; investing owners want a return and a report. The mix points to how management should be set up, and it can change how each person's share of the profit is taxed, which is a point for the CPA to spell out owner by owner.
What is the business expected to earn in its first year, and in its third?
Why ask it
Rough figures are enough. Several choices, above all whether an S corporation election covers its own payroll and filing costs, turn on how much profit there is. An adviser who recommends a structure without asking for a number is working from a template.
Is this a business to sell one day, to hand to family, or to close when the owner stops?
Why ask it
A company built for a sale or for investors leans toward the forms buyers already know, and a practice that ends with its owner can stay simple. A guess is fine here. The useful follow-up is which choices would be hard to undo if the guess turns out wrong.
Will the owners live off the profits or leave them in the company to grow?
Why ask it
Money taken out every year and money kept inside the company are taxed differently from one entity to the next. Be candid about which describes you, since the comparison between a pass-through and a C corporation comes out differently for each.
My spouse and I will both own it. Does that count as one owner or two?
Why ask it
It depends on where you live and how the two of you hold the business. In some states a married couple may be treated as a single owner for federal tax, and elsewhere two spouses usually make a partnership with a return of its own. Settle it before filing, since the answer changes the paperwork and can change how each spouse's earnings are recorded.
What is each owner putting in: cash, equipment or property, or only their work?
Why ask it
A share received in exchange for work can be taxed to the person who receives it, and property that has grown in value may be treated differently going into a corporation than into a partnership or LLC. Put a rough value on every contribution and have the CPA go through them one at a time before anything is transferred.
Does the industry or a professional license limit which entities are allowed?
Why ask it
Many states restrict licensed professions such as law, medicine, accounting and architecture to particular forms, sometimes a professional corporation or a professional LLC. Check with the licensing board before comparing anything else, as the rule may cut the list to one or two.
Liability
If the business were sued or could not pay its debts, what would the owners personally stand to lose?
Why ask it
Begin with a plain inventory: the house, savings, a spouse's assets, a stake in another business. A sole proprietor or general partner typically answers for business debts with all of it, and LLCs and corporations exist largely to put a wall in between. How solid that wall is depends on state law.
What is the worst thing that could realistically go wrong in this line of work?
Why ask it
A food truck, a bookkeeping practice and a roofing crew have very different worst days. Name the event itself: an injured customer, a leaked client file, a job that fails after handover. The more it could cost, the weaker the case for staying a sole proprietorship to save a filing fee.
Which risks would an LLC or corporation not protect the owners from?
Why ask it
An entity generally does not shield a person from their own negligence or malpractice, from debts they signed for personally, or from certain taxes they were responsible for handing over. Have the attorney list the gaps for your state, then find out which of them insurance can fill.
Will a bank, landlord or supplier want a personal guarantee anyway?
Why ask it
New companies are routinely asked for one on a lease, a loan or a credit line, and signing it makes that debt the owner's own whatever the entity. If every large obligation will carry a signature like that, the liability argument rests mostly on lawsuits and much less on debts.
What insurance belongs alongside the entity, and does the entity type change the cost or the cover?
Why ask it
The two do different jobs: an entity limits who can be pursued, and a policy pays the claim. Get a broker to quote under the structure you are leaning toward, and check whether your state's workers' compensation rules treat owners differently from one entity to another.
What do the owners have to keep doing so the liability protection holds up?
Why ask it
A court can set an entity aside when it has been run as an extension of its owner's wallet. The usual list is a separate bank account, contracts signed in the company's name and whatever records the state expects. Ask too whether a one-owner LLC gets weaker protection where you are, because states differ on that.
With several owners, is each one answerable for what the others do?
Why ask it
In a general partnership a partner can usually commit the business, and the others can be held to that debt even if they never heard about it. That is the main reason two people who simply start working together are told to choose something else. Limited partnerships and LLPs exist in many states; find out what each one covers there.
Is there a building, equipment or a brand valuable enough to hold apart from the day-to-day business?
Why ask it
Some owners hold a property or intellectual property in one entity and lease or license it to the operating company, so a claim against operations has less to reach. A second entity doubles the fees and filings, so the question to settle is whether the asset is worth that now or only later.
Taxes and pay
Is the profit taxed on the owners' own returns, or does the company pay tax on it first?
Why ask it
Sole proprietorships, partnerships, S corporations and most LLCs pass their profit through to the owners, while a C corporation pays its own tax and shareholders pay again on dividends. Which comes out ahead depends on current rates and on how much is taken out, so have both run on your projections.
How do the owners get paid under each structure: draws, a salary, distributions or dividends?
Why ask it
Each structure has its own vocabulary and its own routine. A sole proprietor or partner generally takes draws, and an owner who works in an S or C corporation is generally expected to be on payroll. Picture the monthly chore under each, since payroll brings software, deposits and quarterly filings.
How much self-employment or payroll tax would the owners pay under each structure?
Why ask it
This is often the largest dollar difference between the options for a small business, and it is why S corporations come up so early in the conversation. The comparison only means something at your expected profit and after the cost of running payroll is taken off the saving.
If an S corporation election is on the table, what salary would count as reasonable?
Why ask it
The saving depends on paying the working owner a wage that would stand up if the tax agency questioned it, and taking the rest as distributions. Ask how the CPA would support the figure, and below what level of profit they tell clients the election is not worth the trouble.
Can an LLC choose how it is taxed, and which choice fits this business?
Why ask it
In the United States an LLC is a creature of state law that can generally be taxed as a sole proprietorship, a partnership, an S corporation or a C corporation, depending on its owners and the elections it files. That lets the legal question and the tax question be answered one at a time, which is how a careful adviser tends to take them.
Would early losses do more good on the owners' personal returns or held inside the company?
Why ask it
Pass-through structures generally let a startup's losses reach the owners, within limits that are tighter for someone who invests without working in the business. A C corporation keeps its losses to itself. If the plan shows red ink for two years, bring it and ask which limits apply to each owner.
Will the owners owe tax on profit that stays in the business?
Why ask it
In a pass-through they generally do, whether or not a dollar reaches them, and that catches out partners in a company that reinvests everything. Raise the idea of a clause requiring a distribution big enough to cover each owner's tax on their share.
How would a sale of the business be taxed under each structure?
Why ask it
Buyers often want to buy the assets and sellers often want to sell the ownership, and the tax on each route varies with the entity. A C corporation that sells its assets can be taxed once at the company and again when the cash reaches the shareholders. If a sale is the goal, have one rough exit modeled now, as the structure is hard to rearrange in the year a buyer appears.
How are health insurance, retirement contributions and other benefits treated for an owner?
Why ask it
In some structures an owner with more than a small stake is not treated as an ordinary employee for benefits, which changes what the company can deduct and what lands on the owner's own return. Where family health cover or a retirement plan is a big part of the household budget, bring the figures and have the structures compared on that item alone.
What state and local taxes come with each entity type here?
Why ask it
States do not all follow the federal treatment. Some charge a franchise or gross receipts tax on LLCs or corporations, some tax S corporations themselves, and a few cities add their own. Only someone who files in your state can total the yearly bill under each option, so get that total in writing.
Is there a deduction or tax break that depends on the entity, and does it apply to this business?
Why ask it
Some breaks reach only pass-through owners and others only shareholders of certain C corporations, and the rules move with each tax law. Choosing an entity for a break you read about is risky. Check that it covers your industry and income this year, and what happens to the choice if the break lapses.
Investors and co-owners
Will the business raise outside money, and from whom?
Why ask it
Family, a bank, angel investors and venture funds each expect something different. Institutional investors commonly want stock in a C corporation, often one formed in Delaware, while a bank lending against a guarantee cares far less about the form. Name the likely source before paying for a structure built for another one.
Will there be more than one class of ownership, such as preferred shares?
Why ask it
Investors often want rights the founders do not hold: being paid first in a sale, or a veto over certain decisions. An S corporation is limited to a single class of stock, so if this is likely, the choice is between skipping the election and planning for the day it ends.
Will employees be offered equity or stock options?
Why ask it
Stock options are a well-worn path in a corporation. An LLC can share ownership too, through profits interests and similar arrangements, but they take more drafting and employees understand them less readily. If equity is central to hiring, ask to see what a grant would look like in each.
How is a new owner admitted, and what happens to everyone's percentage when one is?
Why ask it
It can be as simple as issuing shares or as involved as amending an operating agreement and revaluing every stake. Have the attorney walk through one admission from offer to signature in the structure you are considering, including whose consent is needed.
Should profits be split in the same proportions as ownership, or differently?
Why ask it
When one founder brings cash and another brings time, an even split of everything rarely feels fair for long. A partnership or an LLC taxed as one can usually write a custom split into its agreement, while a corporation pays out by shares held. If a custom split matters, say so early: it narrows the field.
Who runs things day to day, and which decisions need every owner to agree?
Why ask it
Write down four decisions (borrowing, admitting an owner, selling the company, hiring a relative) and who must sign off on each. That short list becomes the backbone of an operating agreement or bylaws, and it shows whether an LLC run by its members, one run by a manager, or a board suits the group.
What happens if an owner dies, divorces, goes bankrupt or wants out?
Why ask it
Under some structures and in some states an owner's departure can dissolve the business unless the documents say otherwise. A buy-sell provision settles who may buy the share, at what price and over how long. It is easiest to agree while everyone still gets along, which means at formation.
Can an owner sell or pass on a share freely, or should that be restricted?
Why ask it
Corporate shares can usually change hands unless an agreement says no, and LLC and partnership interests often come with limits on who may step in as a full owner. Decide whether you could work beside a co-owner's buyer or heir, and have the documents say so either way.
Fees and paperwork
What does it cost to form each type of entity in this state, with every extra included?
Why ask it
Filing fees differ widely from state to state, and some add a publication requirement, an initial report or a registered agent on top. Take the first-year total from the state's own website or from the attorney, since a formation company's headline price tends to leave things out.
What does each entity cost to keep in good standing every year?
Why ask it
Annual reports, franchise or minimum taxes and agent renewals come due whether or not the business made money. Get the yearly total with its due dates, and find out what a missed one costs: a late fee in some states, loss of good standing in others.
Which state should the entity be formed in?
Why ask it
For a business that works in one state, forming there is usually the simplest and cheapest answer, because an entity formed elsewhere generally has to register at home too and pay both. Delaware and the like mostly come up when investors expect them. Have both routes priced before deciding.
Will the business operate, hire or sell in more than one state or country?
Why ask it
Each extra state where the company counts as doing business usually means a registration there, with its own fee and yearly report, and what counts differs by state. Go through the planned activities one by one, a remote employee, a warehouse, a storefront, and ask which of them triggers it. For another country, ask whether a separate local entity would be needed.
What tax returns does each structure add, and what will preparing them cost?
Why ask it
A sole proprietor reports the business on a personal return. Partnerships and corporations file returns of their own, on their own deadlines, and send a form to each owner. More returns mean a larger preparer's bill, so ask for the annual fee quoted per structure.
What documents and records does each entity call for: an operating agreement, bylaws, minutes, a stock ledger?
Why ask it
Corporations traditionally carry more formality, with directors, officers, meetings and minutes. An LLC is lighter, though many attorneys want a written operating agreement in place even for one owner. Sort the list into what the state requires and what the attorney recommends anyway, and decide who keeps it current.
Is a registered agent required, and who should it be?
Why ask it
Most states require an LLC or corporation to name someone with a street address in the state to receive legal papers. Owners can often name themselves, at the price of an address on the public record and being reachable during business hours. Weigh that against a service's yearly fee.
How much of the owners' information becomes public under each option?
Why ask it
Formation filings can put names and addresses into a searchable state database, and how much is required varies by state and by entity. Rules on reporting who ultimately owns a company have also been changing, so ask what applies today and what may lawfully be kept off the public record.
How much administration will the owners realistically keep up with each month?
Why ask it
The best structure on paper is the wrong one if nobody runs the payroll or files the report. An owner who dislikes paperwork should set the tax saving of a more involved setup against the price of paying someone to keep it in order.
Changing later
If the business starts simple, what would it take to change entity later?
Why ask it
Going from a sole proprietorship to an LLC is usually a filing plus moving contracts and accounts into the new name. Other moves are heavier. Pick the one conversion you are most likely to want and have the attorney describe its steps, fees and timing in your state.
Would converting later bring a tax bill?
Why ask it
Some changes pass without tax and others are treated as a sale or a liquidation; leaving C corporation status tends to be among the costlier ones. This is the strongest reason to pay a CPA before filing anything, because the answer turns on assets and gains the business does not have yet.
What events should prompt a second look at the structure?
Why ask it
Agree the triggers now: profit passing a set figure, a second owner, a first employee, a term sheet, a move to another state. Put them on a calendar or in the engagement letter, so the review follows the event and not a surprise at tax time.
What are the deadlines for making or undoing a tax election?
Why ask it
Elections such as S corporation status have filing windows, and revoking one can bar the company from electing again for a period. Get the dates that apply to an entity formed this month, and what relief exists if one slips.
What would it cost to close the entity if the business does not work out?
Why ask it
A sole proprietorship can usually be wound down by stopping, cancelling its licenses and filing the last returns. An LLC or corporation generally has to be dissolved on the record, sometimes with a tax clearance, and one left open can go on running up annual fees. Worth knowing before choosing something heavy for an experiment.
Which contracts, licenses, bank accounts and loans would have to be redone after a change?
Why ask it
A new entity can mean a new tax ID, new accounts, a lease and customer contracts to be assigned, and permits to be reissued. A long lease or a large customer signed in year one is an argument for settling on the lasting structure before the ink is on either.
Putting it together, which structure fits today, and what is given up by choosing it?
Why ask it
Every option trades something: simplicity for protection, flexibility for a form investors know, lower tax for more paperwork. Ask the adviser to state the drawback of their own recommendation in a sentence. If they cannot name one, a second opinion is worth the fee.
How to work through the choice of entity
Practical guidance for the conversation itself
What to have in hand first
Three numbers
Expected profit in year one, expected profit in year three, and what the owners need to take out to live on. They can be rough. Nearly every answer under Taxes and pay is a calculation, and without figures the adviser can only describe the options, not compare them.
Every owner, by kind
One line per owner: individual or company, resident or not, working or investing, what they are putting in and the share each expects. Add anyone who might join within two years. This single page answers most of Owners and plans and tells an attorney straight away which forms are closed to you.
The worst day in a sentence
Write the one event that could cost more than the business has: a customer hurt on the premises, a contract that goes badly wrong, a loan called in. The Liability group goes much faster when everyone at the table is picturing the same event.
Your state's own fee page
Find the formation and annual fees on the website of the office that registers businesses in your state, usually the secretary of state. Ten minutes there settles half of Fees and paperwork and gives you a figure to check a formation service's quote against.
The five forms and the questions that decide each
Sole proprietorship
One owner, and in most places nothing to file to create it beyond local licenses or a trade name. Owner and business are the same person for debts and for tax. The Liability group decides whether that is acceptable; if the worst day is small and well insured, some owners start here on purpose.
Partnership
Two or more owners carrying on a business together, sometimes without having meant to form anything. Profit passes to the partners and the split can be written to suit them. The deciding questions are the ones about answering for a partner's actions and about what happens when one leaves.
LLC
A state-law entity that separates the owners from the company's debts while leaving the tax treatment open to choice. It suits many small businesses for that reason, though the yearly cost differs sharply between states. Look at the annual fee question and the one on how the LLC would be taxed.
S corporation
A federal tax status in the United States, chosen by a corporation or an LLC that qualifies, and not a separate kind of company. It is usually considered for the payroll tax arithmetic. The questions on reasonable salary, on who the owners are and on classes of ownership decide whether it is open to you and worth it.
C corporation
A company taxed in its own right, with shareholders taxed again on what it pays them. It is the form outside investors and option plans are most used to. If nothing in the Investors and co-owners group applies to you, ask the adviser to explain what the second layer of tax would be buying.
Taking the list to an attorney or a CPA
Who answers which group
Liability, Investors and co-owners and most of Fees and paperwork are an attorney's ground. Taxes and pay belongs to a CPA or tax adviser. Changing later needs both, because a conversion is a legal step with a tax result. If you can afford only one meeting, send the other adviser the notes afterward.
Ask for the comparison in dollars
A side-by-side for your two leading options, with formation cost, yearly fees, preparer fees and estimated tax at your projected profit, turns a debate about labels into a subtraction. It is a fair thing to ask of an adviser you are paying for a first-year setup, so ask for it plainly.
Get the reasons, not only the verdict
"Form an LLC" is a conclusion. What you can reuse is the reasoning: which of your facts drove it, and which fact, if it changed, would change the answer. Write those down, since they are your review triggers for the Changing later group.
If you are the adviser
The first group works as an intake form. Sending it to a new client before the meeting brings back the ownership list, the profit estimate and the exit plan in their own words, and leaves the hour for the questions where the client needs your judgment.
Where this decision goes wrong
Choosing on tax alone
A structure picked for a tax saving can cost more than it saves once payroll, extra returns and state charges are counted, and it may ignore liability and investors altogether. Tax is one of six groups on this page for a reason.
Borrowing someone else's answer
A friend's S corporation or a founder forum's advice to incorporate in Delaware was right, at best, for their profit, their owners and their state. Fees, taxes and even the protection given to a one-owner LLC change at the state line.
Filing, then carrying on as before
Paying personal bills from the company account, signing contracts in your own name and letting the annual report lapse can undo much of what the filing was for. Whatever you pick, set up the separate account and a reminder for the report in the same week.
Skipping the agreement because everyone gets along
Co-owners who agree on everything in month one are exactly the people who can write an exit clause cheaply. The state's default rules fill any silence, and those defaults are seldom what either owner would have picked.