Difference Between Business Entity and Tax Entity
A business or legal entity refers to the type of business structure that is created and recognized under the law. It defines how the business operates, its ownership structure, and its responsibilities, including how it can enter into contracts, be sued, or hold property. A legal entity determines how the business is governed and regulated.
A tax entity refers to how a business is classified by the IRS or other tax authorities for tax purposes. It defines how the income, expenses, and profits of the business are taxed. Importantly, a business’s tax entity is not necessarily tied to its legal entity type; a business may be treated one way legally but elect a different classification for tax purposes.
Which Entity Should I Choose?
It’s important to check with your state's specific requirements or consult a legal professional to ensure you're in compliance when forming your business structure.
Why is Choosing the Correct Business Entity Important?
LLC vs PLLC
As a licensed professional, you will likely need to form a PLLC rather than a standard LLC if your state offers PLLC formation. The purpose of requiring a PLLC is to ensure that licensed professionals remain individually responsible for their professional conduct while allowing the business to benefit from the limited liability protection that an LLC offers.
If your state requires you to form a Professional Limited Liability Company (PLLC) instead of a standard LLC and you form a regular LLC, you may face legal and regulatory issues. Here's what might happen:
- Rejection of Filing: Some states may reject your LLC application if your profession requires a PLLC. Professions like doctors, lawyers, accountants, or architects often fall under this category. The state may notify you that you need to refile as a PLLC.
- Noncompliance with State Laws: If your LLC filing is accepted, but you were supposed to form a PLLC, you could be in violation of state laws. This could lead to penalties, fines, or being prohibited from practicing your profession legally.
- Personal Liability: A key reason states require a PLLC is that members of certain professions need to maintain liability protection for their personal and professional actions. If you form an LLC instead of a PLLC, you might lose that protection, leaving you personally liable for malpractice or professional negligence.
- Difficulty in Licensing: Many professions that require a PLLC also require state licensing boards to approve the business structure. If you file a standard LLC, the licensing board may not approve your business or professional licenses.
Professional Corporations (PC) vs General Stock or Domestic Corporation
If you choose to incorporate with your state or are required to do so, it is important to ensure you’ve done so in line with your state’s requirements. A general stock corporation (also called a general corporation) and a professional corporation (PC) have important differences, particularly in how they are structured, regulated, and who can own them. PCs are also subject to professional regulations and oversight.
As a licensed professional, you will likely need to form a Professional Corporation (PC) rather than a standard General or Domestic Corporation. If your state requires you to form a PC instead of a General Corporation and you form a General Corporation, you may face legal and regulatory issues. Here's what might happen:
- Noncompliance with Licensing Requirements: Forming a general corporation instead of a professional corporation may violate licensing regulations in your state. This can lead to fines or other penalties and could jeopardize your professional license.
- Ownership Restrictions: In a professional corporation, only licensed professionals (e.g., other therapists) can own shares. A general corporation allows anyone to own shares, including non-licensed individuals. Allowing non-therapists to own shares in your practice through a general corporation could violate state laws governing your profession, which could lead to further legal penalties and corporate invalidation. You may have to restructure ownership to comply with laws that limit ownership of therapy practices to licensed clinicians.
- Different Tax Rules: PCs are sometimes taxed differently from general corporations. While both can be structured as C-corporations or S-corporations, some states have specific tax rules for PCs that could lead to penalties or higher taxes if you fail to form the correct entity.
- Potential Invalidity of Contracts: Many states require therapy practices to be organized as professional corporations to ensure that services are provided by licensed individuals. Contracts signed under a general corporation may not be legally valid.
What should I do if I’ve formed the wrong business entity?
If you think you may have formed the wrong business entity, don’t panic. Depending on your circumstances, the process can be complex and time-intensive, but it is important to resolve any issues with your business entity formation as soon as possible.
If you formed your business entity through a former CPA or service such as LegalZoom, Heard recommends reaching back out to your legal service provider for additional support in correcting your entity formation. Below is a list of some actions you may need to take, depending on your circumstances and state requirements:
- Dissolving your LLC or Corporation and filing a final year return
- Amending your LLC filing to PLLC filing
- Registering for a new EIN
- Re-applying for S-Corporation Status
- Opening new bank accounts
Please Note: Heard does not currently offer support for Business Entity Formation or Dissolution.