Choosing the right entity for your small business is a critical decision, both professionally and personally, but understanding and evaluation the nuances of each business type can be daunting. To begin, tackling the process, consider two primary issues that often control the entity selection process: potential personal liability of the business owner and tax consequences to the business owner.

Five business entities are commonly used by today’s small-business owners, including the sole proprietorship, partnership, C corporation, Subchapter S corporation and the limited liability company. Each of these entities has its benefits and drawbacks that, when evaluated in light of liability and taxation issues, will guide you in choosing the right entity for your needs.

Most businesses are potentially subject to claims that could result in the loss of some or all of the business owner’s personal assets. However, some business entities offer the business owner more personal liability protection than others. Many small businesses operate as sole proprietorships or partnerships, which are often the least formal entities to form and operate. However, neither a sole proprietorship nor a partnership provides the business owner with protection of their personal assets in the event of a lawsuit against the company. Thus, sole proprietorships and partnerships are rarely recommended as the proper form of business entity for small-business owners.

By contrast, C corporations, Subchapter S corporations and LLC’s protect business owners from potential personal liability resulting from claims made against the business, provided the business owner complies with corporate formalities mandated by territorial law, including, but not limited to keeping a separate bank account for the company, filing proper tax returns, maintaining good standing with the Corporate and Tradename Division of the Office of the Lieutenant Governor and keeping proper written records of major corporate actions.

In addition to liability issues, there are a number of tax issues that must be considered by a small-business owner during the entity selection process. While the owners of a sole proprietorship and partnerships may enjoy tax efficiencies, they must also consider the imposition of a self-employment tax in addition to the personal income tax paid. This factor, when combined with the lack of personal liability protection discussed previously, generally removes these entities from further consideration in the selection process.

While owners of a C corporation are not subject to the self-employment taxes imposed on owners of sole proprietorships and partnerships, there are several tax consequences to consider when evaluating the C corporation as an entity for your small business. In addition to the burden of filing multiple tax returns, the owners/shareholders of a C corporation are subject to double taxation – the corporation is subject to corporate income tax at the federal level and a 10% surtax on the territorial level on all corporate earnings, and the owners/shareholders are subject to a second tax at individual rates upon the distribution of corporate earnings to the owners/shareholders. These factors typically eliminate the C corporation as a viable business entity for a small-business owner.

As with the C corporation, the Subchapter S corporation’s shareholders are not subject to the self-employment taxes. A major advantage, however, of a Subchapter S corporation over a C corporation is pass-through treatment, which allows all income from the business to “pass-through” directly to the owner’s personal income tax return. Despite the fact that the owner of the Subchapter S still must file a separate tax return with the Virgin Islands Bureau of Internal Revenue for informational purposes, the entity itself is not subject to tax liability, making the Subchapter S corporation a viable choice for a small-business entity.

Like the shareholders of a Subchapter S Corporation, the owners of an LLC are subject to taxation only at the personal level. Moreover, while an LLC owned by two or more owners will generally be required to file a separate informational tax return, a single-owner LLC can be treated as a disregarded entity for tax purposes, allowing the individual owner to record LLC income or loss on their personal income tax return without having to file a separate return for the LLC. These characteristics generally make the LLC another viable option for the small-business entity. However, a major disadvantage of the LLC is that individual owners are generally required to pay self-employment tax in addition to the personal income tax. While other operational and ownership factors may lead to a different choice, the employment tax issue often leads attorneys and accountants to recommend that small business owners choose an S corporation, rather than an LLC.

Regardless of the entity form initially selected, business owners should periodically consult with their attorney and accountant to reassess their business and to review current federal and territorial law to ensure that they use the form that provides the most benefit for their small business.