Basic Business Entities

There are three basic small business entities with variations within. The three basic entities are-

• Limited Liability Company (LLC), the crowd favorite
• Limited Partnership (LP), Limited Liability Partnership (LLP), Limited Liability Limited Partnership (LLLP, or triple “L” P as the cool kids say), or the legacy dinosaur General Partnership (GP)
• C Corporation (for profit), and the Personal Service Corporation (PSC)

There is an additional entity subtype with the “Professional” prefix. Some states require certain professionals, such as doctors, attorneys, accountants and engineers, to use a Professional LLC (the PLLC), Professional Corporation (the PC) or another specifically permitted entity if they want to practice through an entity. Since you don’t see too many LLPs these days, you don’t see too many PLLPs either. California goes a step further and does not allow an LLC to render professional services at all (Cal. Corp. Code Section 17701.04(e)), so there is no such thing as a California PLLC. A California physician, dentist or chiropractor who wants a separate entity will generally be looking at the applicable professional corporation instead (attorneys and accountants also get the LLP option).

Two notables are missing from the list. First, sole proprietors are not an entity nor is the variant or close cousin of “Doing Business As” (DBA). If you wake up and want to sell used copiers, you can, right now, without any formalized structure. It is not smart, but certainly permissible. At times sole proprietors are interchanged with single-member limited liability companies (SMLLC) since the IRS and most states consider a SMLLC to be a disregarded entity for taxation, and both a sole proprietorship and a SMLLC will end up on Schedule C of your Form 1040 (or Schedule E if the SMLLC holds a rental, which is a whole different book). The disregarded default comes straight from the check-the-box regulations at Treas. Reg. 301.7701-3(b)(1)–

Except as provided in paragraph (b)(3) of this section, unless the entity elects otherwise, a domestic eligible entity is- (i) A partnership if it has two or more members; or (ii) Disregarded as an entity separate from its owner if it has a single owner.

However, a sole proprietorship and a SMLLC are truly different in several underlying ways, starting with liability protection, which we get into shortly.

Also note how an S corporation is not listed. It is not an entity. It is a taxation election. IRC Section 1361(a)(1) says it plainly-

For purposes of this title, the term “S corporation” means, with respect to any taxable year, a small business corporation for which an election under section 1362(a) is in effect for such taxable year.

The underlying entity has to be one of the above, and usually it is an LLC (either single-member or multi-member) for the ease of formation including documentation. How does an LLC become a “small business corporation” in the first place? The check-the-box regulations handle it. When an LLC files Form 2553 to elect S Corp status, it is deemed to have also elected to be taxed as a corporation (Treas. Reg. 301.7701-3(c)(1)(v)(C)). One form, two elections. We cover the mechanics, deadlines and late election relief in Chapter 6. Fun stuff!

Let’s chat about each of these entities in turn. Here we go…