What Is a Business Entity?

Definition & Examples of a Business Entity

Business people shaking hands.
••• Ridofranz / Getty Images

A business entity is an organization that's formed to conduct business. The type of business entity formed determines how a business is taxed and its exposure to liability.

Learn more about how business entities work.

What Is a Business Entity?

Business entities refer to the type or structure of a business, not what it does. How it's structured affects how taxes are paid and liabilities are determined. Business entities are usually created at the state level, often by filing documents with a state agency such as the Secretary of State.

  • Alternate name: Business structure

How Business Entities Work

Choosing a business entity is one of the first steps new businesses should take. It determines what tax form you file and what happens if your business is sued. Many business structures offer protection for your personal assets. If you're sued, your business assets could be at risk, but your personal assets won't be.

New business entities are formed by filing paperwork with your state, if required, and paying any required fees. The best type of business entity depends on the type of business and the number of owners. It's one of the most important decisions business owners make, so it's best to consult tax and legal professionals for advice specific to your business.

The Small Business Administration has local offices that can advise on setting up your business. It also partners with vetted organizations that provide free or low-cost business advice, like the Women's Business Center, and can direct you to appropriate resources.

Types of Business Entities

States recognize several business entities, but most business owners will choose one of five: corporations, general partnerships, limited liability companies, limited liability partnerships, and sole proprietorships.

Sole Proprietorships

A sole proprietorship is an unincorporated business with one owner or two owners who are married. This is the default entity if you start a business and you're the only owner, and you typically don't need to register with your state. You may have to obtain a business license or permits depending on the type of business you're conducting.

Freelancers and consultants are often sole proprietors. With this business entity, you file one tax return rather than separate business and personal tax returns. With this type of structure, your personal assets could be at risk if your business is sued.

General Partnerships

A general partnership is an unincorporated business with two or more owners, and all partners manage the business and share the profits. It's the default form of ownership for businesses with multiple owners. As with a sole proprietorship, your personal assets could be at risk if your business is sued, but all the partners share that risk.

Limited Partnership

A limited partnership is a registered business entity. You have two types of partners in this entity: general partners, who actively manage and assume liability for the business, and limited partners, who act only as investors without managing the business, limiting their liability and tax burden.

Partnerships must file returns to report income, deductions, gains, and losses, but they do not pay income tax. The profits and losses are passed through to the partners.

Corporations

A corporation is an independent, legal entity that separates your personal and business assets. Also called a C corporation, a corporation has shareholders, a board of directors, and officers. Setting up a corporation is more complicated than setting up a sole proprietorship or partnership; there's more paperwork and fees are higher. One drawback to a C corporation is that profits can be taxed twice—once when the profits are made and a second time when dividends are paid.

S corporations are a special type of corporation that offers pass-through taxation. Profits are passed through to the owners' personal income without being subject to corporate tax. It avoids the double taxation that can occur with C corporations. S corporations can't have more than 100 shareholders and all must be U.S. citizens.

Limited Liability Companies

Limited liability companies (LLCs) offer liability protection. They're simpler to set up than corporations and you can choose whether it's treated as a corporation or as a pass-through entity for tax purposes. LLCs can have one owner (referred to as a member) or many, so it's a useful alternative to sole proprietorship for freelancers and other individual business owners.

Key Takeaways

  • A business entity is an organization that's formed to conduct business. The type of entity determines how a business is taxed and its exposure to liability.
  • You choose a business entity when you start a business. It's formed by filing paperwork with your state (if required). 
  • There are several types of business entities. Sole proprietorships and general partnerships are unincorporated businesses, while limited liability partnerships provide some liability protection for investors. Corporations and LLCs separate personal and business taxes and liability. 

Article Sources

  1. IRS. "Sole Proprietorships." Accessed Nov. 15, 2020.

  2. IRS. "Partnerships." Accessed Nov. 15, 2020.

  3. SBA. "Choose a Business Structure." Accessed Nov. 15, 2020.

  4. IRS. "Limited Liability Company (LLC)." Accessed Nov. 15, 2020.