Selecting The Correct Business Entity

Selecting the Correct Business Entity

When forming a business, a multitude of important legal and tax issues must be addressed. You must determine what business entity structure best suits your needs (sole proprietorship, general partnership, professional limited liability company, professional corporation, etc.). In making this determination, it is crucial that you have a clear understanding of the potential risks and the liability issues associated with your business. You also need to consider which entity formation will provide the best tax structure for your business. Your company will need to obtain a variety of permits, licenses and registrations. If you intend to finance the startup of your new practice, you will be entering into contracts with banks, suppliers, and vendors. To make sure you and your business are protected, your legal and tax advisors should carefully review these agreements before they are executed.

The most common business structures are:

Sole proprietorship

A sole proprietorship is the quickest and easiest way to set up a business operation since it is unincorporated and has only one owner. The owner of the business is solely liable for its obligations. He or she simply utilizes his or her personally-owned assets for business purposes.

General partnership

A general partnership is formed by two or more people engaging in business to make a profit. The partners jointly own the assets, profits, and losses. General partnerships do not require registration with any state or local government, except with regard to business tax registration and recording obligations. The partnership agreement or organization documents can define the duties and obligations of each partner, but these delegations have no effect on each partner’s liability.


A limited liability company (LLC) is basically a hybrid between a partnership and a corporation. The owners of a LLC (known as the “members”) have a limited liability to the company’s actions along with flow-through tax benefits of a general partnership. An LLC allows members the option of participating directly in the management of the business or designating certain members or nonmembers as managers.

Limited partnership

A limited partnership typically has the same characteristics of a general partnership, except that the limited partners have limited liability protection. In addition, limited partnerships must file organizational documents with governmental authorities.

S corporation

S corporations are formed by filing a charter with the Tennessee secretary of state. The biggest attraction of this structure is its tax advantages. S corporations are usually taxed like a partnership and the profits and losses flow through to the shareholders. The shareholders, board of directors, and officers of an S corporation must have regular meetings and maintain company minutes. They must elect for the corporation to be taxed as an S corporation.

S corporations have certain limitations:

  • Maximum of 100 shareholders
  • Must have only one class of stock (but can have non-voting and voting stock)
  • Only individuals, certain types of trusts and estates, and certain tax-exempt organizations can be shareholders (i.e., no for-profit entity can be a shareholder)
  • No subsidiaries except for a subsidiary that is owned 100% by the parent S corporation

C corporation

Like S corporations, C corporations are formed by filing a charter with the Tennessee secretary of state. The difference is that a C corporation is subject to federal corporate income taxes while an S corporation is not.

In a C corporation:

  • The shareholders, board of directors, and officers must execute certain organizational minutes
  • All income and losses typically remain and are taxed at the corporate level (i.e., no benefit of flow-through)
  • Shareholders must pay dividend taxes on any distribution of earnings they receive from the company.