A separate business entity is a business that’s legally and financially separate from its owners. A separate business entity has a separate bank account, with separate transactions and payroll for employees. Think of it as you and your business are two completely separate individuals.
Before you choose what type of business entity, let’s talk about what is required and whether or not it’s the right choice.
Should You Make Your Business a Separate Entity?
The short answer is, yes. Even if you operate as a sole proprietor, you should consider your business as a separate entity. Even if you file your business taxes on your personal return as a sole proprietor.
There’s no one reason why you should set up your business as a separate entity. But one of the main reasons for doing so is to separate your business liability from your owners; either yourself, other owners, or all of you.
If the nature of your business is considered particularly risky, having a separate business entity can remove (or at least mitigate) your personal liability. Liability protection is important if you don’t want to be personally liable for any business liabilities.
Liability can come in many forms. For instance, specific products you sell or how large your business is, if you have employees. Employee lawsuits — like harassment, discrimination, and accidents — can be expensive. A separate business entity can remove you from being personally responsible for any legal problems that may arise in your business.
What’s the Benefit of Creating a Separate Business Entity?
While you might think a separate business entity is a hassle to set up and manage, think of how much you’ll benefit from doing so.
- Tax breaks. When you’re a sole proprietorship, you and your business are considered one and the same—you file business and personal taxes together. Your assets and liabilities are reported on your personal income taxes. When you file as an LLC, S-Corp or C-Corp, you deal with business taxes. S-Corporations aren’t subjected to corporate income tax and benefit from “pass-through taxation,” or when shareholders can report business income and losses on their personal tax returns. An LLC also has pass-through taxation.
- Liability protection. An LLC, otherwise known as a Limited Liability Company, offers similar liability protection as an S-Corp and C-Corp. If you act as a sole proprietorship, you are on the hook for your company’s liabilities. When you use an LLC, S-Corp, or C-Corp, the separate business entity protects you personally.
- Management structure. With a sole proprietorship, there’s virtually no distinction between the business and you personally. The business is owned and operated by one person. With an LLC, you’re separated from your business. You can hire staff and appoint owners as you see fit. Or you can continue to run the business solo with personal liability protection if your company is sued, for example.
- Transferability. If you ever want to sell your business or you wish to someday get your business acquired, it is much easier if the business is an LLC, S-Corp or other corporation (although in some cases, you can transfer specific assets to another sole proprietorship).
What Types of Businesses are Separate Entities?
If you’re moving away from sole proprietorship, you have a few options to choose from when classifying your business.
- LLC. A Limited Liability Company, or LLC, is a company where the owners are called members, and are not personally responsible for a business’s debt and liability. You’d be protected against lawsuits, debts and reducing your personal liability in the event of a lawsuit or other business fallout.
- S-Corporation. If you’re an S-Corp, you not only have the benefit of pass-through taxation, you’ll also keep your personal assets separate from your business. Since an S-Corp is a separate business entity, you’re protected in case your company faces hardship or lawsuits.
- C-Corporation. C-Corps face double taxation, but owners are still not personally on the hook for a company’s debt or lawsuits. Your liability is minimized and your assets are still protected, thanks to your company’s listing as a separate business entity.
You won’t get the same benefits if you’re listed as anything other than an LLC, S-Corp, or C-Corp.
- Sole proprietorship. While there’s less paperwork and administrative hassle, a sole proprietorship means you and your business are basically the same. Your company isn’t a separate business entity. That means your personal assets will likely get seized in the event your company faces debt or another type of hardship. Expect to pay out of pocket if your business gets sued.
- Independent contractors and partnerships. If you fall into the category of an independent contractor or you’re in a partnership, you’re also personally responsible for your company’s liabilities. For partnerships, each partner is personally responsible for lawsuits or other liabilities.
How to Keep A Separate Business Entity
If you’re ready to move your company into becoming a separate business entity, there are a few things you’ll need to do.
For starters, you’ll want to choose between an LLC, S-Corp, or C-Corp. You’ll want to weigh the differences between them all to see which one is right for your company. When you do this, you’ll want to get an Employee ID Number, or EIN. When you complete W-9s for clients, you’re requested to complete either your EIN or Social Security Number. An EIN is like your company’s Social Security Number.
After that, you’ll want to get your accounting structure in order. Open a business checking account and if necessary, a business credit card. Before getting a credit card, check your company’s business credit score and credit report to make sure you’re eligible for the lowest interest rates and best terms.
When you file payroll or buy something that’s business-related, it will all pass through your company accounts, rather than your personal ones. Do your best to keep your company records and personal records separate. If you don’t, you will lose the benefits of the liability protection. In other words, if you don’t treat the corporation as a separate entity, neither will the court.
If you have any company benefits, like a car or cell phone that the company pays for, make sure you document mileage, usage, and payments in the event you get audited. Anything you pay for that’s business-related comes from your business accounts, not you, personally. If you ever need to pay for something out of your personal account, instead try giving your company a loan that would eventually be paid back. Or you might consider it an “investment” in your company that might not need to get repaid.
As you build your company’s separate entity, remember that effective money management is a key to making sure you’re not mingling business and personal assets.
Final Word: Separate Business Entity
Having a separate business entity isn’t for every person or business. Some owners don’t need to be removed from their companies, while other businesses would benefit from becoming a corporation.
If you’re thinking about making your company a separate business entity, find the right listing for you. Whether it’s an LLC, S-Corporation, or C-Corporation, make sure the one you choose doesn’t require owners to be personally responsible for a company’s assets and liabilities. Avoid sole proprietorships and partnerships if you’re hoping to become a separate business entity.
While many companies don’t think they’ll need the protection of becoming a separate business entity, lots of businesses stand to benefit from operating this way. Regardless of the work you do, remember that your company is a business and should be treated professionally, even by its owners.
This article was originally written on March 17, 2020 and updated on July 18, 2022.