Entity Formation: How and Why to Form a Business Entity

If you’ve never heard of entity formation, look no further.

Forming an entity is something that most businesses do because it provides a plethora of benefits. However, many startup entrepreneurs have a hard time figuring out what an entity is and how they could gain from it.

When you form an entity, you’re essentially making it official that you have a business. This lets you operate legally and expand your business without running the risk of breaking the law. Several types of entities exist depending on what kind of business you have and they all have unique benefits.

Keep on reading to learn more about business entities!

What Is a Business Entity?

Business entities are some of the most common organizations formed by individuals. These are formed at the state level, so they need to follow state laws. Most states require business owners to file documents at agencies like the Secretary of State before they can legally start their business.

Here are the main business entities:

• Sole proprietorships
• Partnerships
• Corporations
• Limited liability companies (LLCs)
• Limited liability partnerships

One of the simpler business entities to form is a sole proprietorship. These don’t require documents like other entity types, but there’s only one owner so they’re liable for everything related to their business.

A partnership is a type of business entity that involves two or more people. Similar to sole proprietorships, these don’t require any legal documents. 

A corporation is the most common type of business entity because all owners have limited liability, preventing them from being liable for more than what they put into the company.

Disregarded Business Entities

Business entities are typically required to file taxes. However, owners of a sole proprietorship only need to file a single tax return instead of multiple for their business. When this happens, the entity and the owner are considered as one thing.

In this case, the IRS disregards these business entities because the owners just need to report what their income and deductions are. When the owner files their taxes, they’ll report their business information with their personal tax information.

One-member businesses can also be considered separate entities. If the owner wants to make their business a separate entity, they need to fill out forms that’ll classify the entity’s independence. If they don’t file a Form 8832, their business will still be disregarded.

Why You Would Form It

While forming an entity seems like a simple process, it comes with several benefits that you otherwise couldn’t get. Even if you have a small business, you’ll feel inclined to form an entity when you find out why they’re crucial.

These are the common reasons why people form entities:

Protect Business Owners

One of the main reasons people form business entities is to protect the owners of companies. Most entities are distinct from their owners. So if a company released a fault product, the company would be to blame instead of the owner.

This prevents owners from being exposed to liability, but the owner can be held liable for abusing the business entity. This usually happens in cases where an owner is breaking the law.

Save Taxes

Depending on the size of a business and how much money it’s earning, owners can save on taxes when they form the right entity. Some entities will get tax cuts based on their income and expenses, so it’s best to speak with a tax advisor before you decide to start a business.

Structured Business Operations

When most people start a business for the first time, they often don’t have a good idea of how they should operate. Fortunately, forming an entity gives you several rules to follow (laws), making it easier to come up with a business plan.

Professional Image

Startup companies are common, but many people want to work with companies that show professionalism. You won’t always get customers based on the products or services you offer, so forming an entity makes your company look more professional.

Doing this also makes it easier to spread your name because your advertisements will look legitimate, increasing the likelihood that viewers look into your company.

How to Form a Business Entity

Forming a business entity doesn’t take long providing that you follow the necessary steps. One of the first things you’ll need to do is decide what type of entity you want to follow. If you plan on having several owners, forming a sole proprietorship won’t be an option.

Going the LLC route would be the best because it doesn’t come with many hurdles and can be done by almost anyone. All you need to do is select your name and apply for a FEIN (Federal Tax Identification Number) with the IRS. This can be done online and you don’t have to worry about fees.

The next thing you’ll do is complete the necessary forms that are provided on the IRS’s website. When you fill out these forms, you can send them to the Secretary of State to get them approved. If you can, try to consult an attorney throughout this process to ensure that you’re doing everything correctly.

Start Thinking About an Entity Formation Today

Now that you know what entities are and how they work, the next thing to do is form a business entity for yourself. The entity formation process can be done within days, you’ll just need to come up with a good business plan to have something to rely on.

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