Business Entity Formation and Tax Implications


One of the legal services that corporate attorneys provide is advising startups with strategies to protect their long term interests. Each business entity has specific tax requirements and a San Jose business attorney can help you determine which is best for your venture. In this article, we’ll discuss specific business entities and how they’re taxed.

  • Sole proprietorship

A sole proprietorship is not a business entity. It’s the default state of an individual who owns a business. Those who run sole proprietorships are taxed as individuals with assets and profits. The biggest pitfall of the sole proprietorship is that you end up paying both the employee and the employer side of social security. These are typically split between employer and employee.

Further, the debts and liabilities of the business are attached to the name of the sole proprietor. So, if the business goes into bankruptcy, so does the sole proprietor. On the other hand, the profits of the business and the income of the business owner are not double taxed.

  • General partnership

General partnerships are similar to sole proprietorships in which a group of individuals work together, but are taxed as individuals and not businesses. In other words, their part of the partnership is taxed in accord with the rules regarding sole proprietorships based on how much they earn on a yearly basis.

  • LLCs

Limited liability companies are also treated like sole proprietorships. In other words, the business isn’t taxed, the partners are. Single-member LLCs are treated as sole proprietorships while multi-member LLCs are treated as general partnerships. Alternatively, LLCs can elect to be treated as corporations that have different tax liabilities. This can sometimes benefit the company and its individual members.

  • C Corporation

Corporations are taxed as business entities as opposed to taxing individuals within a business entity. However, shareholders are taxed again on their gains and employees pay income tax. They are costly to set up and cost more to sustain. On the other hand, they are more likely to draw investors due to years of established rules and legal precedent. C Corporations provide investors with a great deal of safety when investing.

  • S Corporation

To avoid the double taxation of a C corporation, the formation of an S corporation is useful. Instead of getting double-taxed at the corporate and shareholder level, the S corporation passes everything onto the investors who are taxed as individuals. However, liabilities are passed as well, meaning investors could take a loss.

Corporations versus other business entities

A corporation allows for a structural division between management and ownership—a factor not present in non-corporate business entities. This protects investors from debts incurred by the corporation itself. They never become the personal liability of any of the shareholders, officers, or the board. For investors, this adds a layer of protection, more confidence to invest, and a better overall outcome.

Talk to a San Jose Business Lawyer Today

Structure Law Group, LLP’s San Jose business law attorneys help startups choose what business entity best suits their needs, draft articles of incorporation, and more to help secure investors safely and legally. You can call (408) 441-7500 in Silicon Valley or (310) 818-7500 in Los Angeles, or you can contact us online to schedule an initial consultation.