Business entity types for closely held businesses

New Jersey businesses with five or fewer members and whose businesses are not in the professional service industry are considered to be closely held businesses by the IRS. Closely held businesses may select from several different entity types when the business is formed. Each type has different requirements and potential tax liabilities.

Understanding the various entities, their tax consequences and reporting requirements is very important. Among the entity types from which businesses can choose include S corporations, sole proprietorships, LLCs and partnerships, each of which have varying reporting requirements, tax savings or consequences, and varying levels of liability protection.

Over 70 percent of small businesses in the U.S. are run as sole proprietorships. The advantage of a sole proprietorship is that it is not an incorporated entity type and thus does not have many of the associated reporting requirements. Conversely, however, a large disadvantage is that there is no liability protection, which means that if the business is sued, the owner will also be legally responsible and he or she may lose his or her own personal assets.

LLCs are popular choices for many small businesses because the individual owners are not personally liable for the debts and business activities of the business. Like LLCs, S Corporations provide liability protection and the income from them pass through to the individual owners’ personal income tax returns. Both are popular but have differences that need to be investigated.

With partnerships, the partners share in the profits equally, regardless of the amount of work performed. This can be a good choice for people who share similar business visions, but a poor one for those who are not able to work well together. Business entity choices should be carefully considered. When a business is selecting an entity type, they should consider all of the available options.

Source: IRS, “Entities”

Source: SBA.gov, “Top 10 Questions About Small Business Incorporation Answered”, Caron Beesley, December 30, 2014