There are several different types of entities in the world of business that are defined in the IRS’s Internal Revenue Code. Each entity has its own tax implications and slightly different filing statuses. The entity that a business chooses can affect how the business is run, the tax liability the business will have and the reports that will be required.
The three main entity types are known as a closely held corporation, a personal holding company and a personal services corporation. Most businesses start out as closely held corporations. Closely held corporations are those in which five or fewer people hold a majority of the company’s stocks. The business activity is also not focused on the provision of personal services, unlike the personal services corporation type.
Closely held corporations have limited tax treatment of certain types of business activities. For example, the compensation paid to the corporate officers, passive activity losses and the applicable at-risk rules are examples of items that are subjected to additional tax limitations.
When people are starting a business, they should begin with writing a business plan. Part of the plan should address how the business will be formed and what type of entity will be chosen. The entity can affect the taxes and other liabilities of the company and the business’s owners. It is important to have a thorough understanding of how businesses are taxed, how they complete their reporting requirements and whether any of the company’s liability will extend to the owner. When people are uncertain which type of entity would be best for their business or to garner a better understanding of tax implications, they may benefit by speaking with a business and commercial law attorney.
Source: IRS, “Entities”, November 13, 2014
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