Question 1

What type of business entity should I choose?

Accepted Answer

When starting a new business, a business owner can choose to operate the business as a sole proprietor or, if the business has multiple owners, as a general partnership. An owner seeking protection from creditors and other types of liabilities can also choose to operate the business as a corporation, a limited partnership, or a limited liability company. 
Operating a business as a corporation, a limited partnership, or a limited liability company can provide significant liability protection, but an owner who personally guarantees a debt or other obligation will be personally liable for the debt or obligation. Some laws – such as state tax and employment laws – also hold business entity owners and governing persons accountable for legal violations.

Question 2

What type of business entity is best for my business?

Accepted Answer

A business owner may choose to operate a business as a limited partnership, a corporation, or limited liability company. 
Historically, business owners operated as sole proprietors and were directly liable for the debts and liabilities of their businesses. Around the turn of the 19th century, states began introducing legislation enabling incorporation by private companies. The Federal government was quick to tax corporate income beginning in 1909, which led to the popularity of limited partnerships and the Uniform Limited Partnership Act which standardized limited partnership laws throughout the country. 
More than 50 years later, in 1977, the first limited liability company statute was enacted.  Over the following decades, other states followed. Currently, the limited liability company is the preferred form of business entity for small and medium-sized businesses because it offers both limited liability and the pass-through taxation and operational flexibility of a partnership.

Question 3

Why is a limited liability company the preferred choice of business entity?

Accepted Answer

A limited liability company (“LLC”) is a creature of state law. It offers limited liability similar to a corporation but is governed by contract (called an “operating agreement” or “company agreement”) similar to a partnership. If there is no operating agreement or if the operating agreement is silent on an issue, applicable provisions of the state LLC statute will serve as the gap filler (similar to partnership law).
LLCs are recognized for legal purposes but are not a recognized category by the IRS. For tax purposes, there are only “disregarded entities,” “partnerships,” and “corporations.” For tax purposes, a single member LLC is classified by federal tax law as a “disregarded entity” and an LLC with multiple members is classified as a “partnership.” By filing the appropriate tax election, members of an LLC can elect for the LLC to be classified, for tax purposes, as a “corporation” (either a C corporation or S corporation). 
Because of its flexibility, there are few tax disadvantages associated with forming an LLC that will operate domestically.  Because an LLC is considered a “hybrid” business structure, however, an LLC may not be the appropriate entity structure for international tax planning.

Question 4

How is owner compensation taxed differently depending on a business entity’s tax classification?

Accepted Answer

If you are a shareholder in an S corporation, then you will be an employee of the corporation and the corporation will pay you a salary (which must be reasonable in relation to the services you perform). The corporation will pay the employer portion of Social Security and Medicare Taxes and withhold from your salary the employee portion of the tax. For 2026, the combined rate for Social Security and Medicare tax is 15.3% on income up to $184,500 (7.65% of which will be paid by the corporation, and 7.65% of which will be withheld from your salary). So if the corporation pays you a $100,000 salary, the corporation will pay $7,650 in payroll tax (which is a deductible business expense for the corporation) and will withhold from your salary $7,650.
Salary and wages above $184,500 are subject only to the Medicare portion of the tax which is 2.9% (1.45% of which is paid by the corporation, and 1.45% of which is withheld from salary).  So if your salary is $200,000, the first $184,500 is subject to both Social Security and Medicare tax (combined rate of 15.3%), and the remaining $15,500 is subject to only the Medicare portion of the tax (i.e., 2.9%).
If you have an individual income of more than $200,000 ($250,000 for married couples filing jointly), you will pay an additional 0.9% in Medicare taxes. 
An owner of an entity disregarded for tax purposes or taxed as a partnership, however, cannot be employed by his or her own entity and, therefore, cannot be paid a “salary” or “wages.” If you are sole proprietor or the owner of a single member LLC disregarded for tax purposes, all of the business income, less deductible business expenses, will be considered your income and be reported on your personal income tax as discussed above. If you are a partner in an entity taxed as a partnership, you will receive “guaranteed payments” from the partnership as compensation for services. Guaranteed payments are deductible to the partnership, the same as wages, but are not subject to Social Security and Medicare taxes.
So how does an owner of an unincorporated entity pay Social Security and Medicare tax? The answer is self-employment tax, which is paid on “net earnings from employment.” “Net earnings from self-employment” includes all gross income derived from carrying on a trade or business, less allowable business deductions, plus your distributive share (whether or not distributed) of income or loss from any trade or business carried on by a partnership in which you are a general partner. Excluded from “self-employment income” are enumerated types of investment income, including stock dividends, certain types of interest, and capital gains income. Also excluded is the distributive share of any item of income or loss of a limited partner, other than guaranteed payments to that partner for services actually rendered to or on behalf of the partnership or for use of the partner’s capital (which is important to passive investors). 
Self-employment tax is similar to employer payroll taxes. Social Security and Medicare tax rates are the same, and apply up to the same limits (i.e., Social Security tax applies to all income up to $184,500 of net income from employment, and Medicare applies to all net income from employment, with a 0.9% surcharge for high income individuals). 
Self-employment tax differs from payroll taxes, however, in how it is collected. Unlike payroll taxes, which are paid partly by the employer and partly withheld from an employee’s salary, self-employment tax is paid wholly by the business owner. Similar to payroll taxes, however, one-half of the employment tax is a deductible business expense. 
Self-employment tax also differs from payroll taxes in that it applies to all income from self-employment; whereas payroll taxes apply only to salary and wages (and, importantly, not to shareholder distributions). For this reason, sole proprietors, owners of disregarded entities, and entities taxed as partnerships may pay more in Social Security and Medicare taxes than owners of an entity taxed as an S corporation.  
By way of example, in 2026, the sole shareholder of an “S” corporation operating a restaurant receives a $60,000 salary (considered a reasonable salary for a restaurant manager) and recognizes $40,000 in profit. Only the $60,000 in salary is subject to Social Security and Medicare tax. The $40,000 profit is subject only to income tax. The same individual, operating as a sole proprietorship recognizing $100,000 net earnings from self-employment, however, would have $100,000 of income subject to both self-employment tax and income tax.

Question 5

What is a buy sell agreement?

Accepted Answer

There are various reasons that a business entity owner may want or need to transfer their ownership interest. 
Obviously, if a business owner dies, their interest should pass to the beneficiaries of their will or to their heirs at law. If a business owner gets divorced, their former spouse may be entitled to a portion of the interest or value of the interest. If an interest is tied to an owner’s personal efforts, the owner may want to be bought out or the other owners may want the right to buy out the inactive owner.   
For these reasons, it is prudent for business owners to consider entering into a “buy sell” agreement which governs the sale and transfer of their interests and creates cross purchase opportunities for the other owners to buy their interests in the event of a proposed transfer. A buy sell agreement may be a standalone document or buy sell provisions may be included in another agreement (for example, an LLC operating agreement or a corporate shareholder agreement).

Question 6

What is a push pull provision?

Accepted Answer

A push pull provision (sometimes called a “Russian Roulette,” “Chinese Shotgun,” or “Texas Draw” provision) triggers when one of the business owners wants to either leave the business entirely or exercise full control. It works best in situations where there are two equal owners, but it can work in situations where there are more than two owners.
Under a typical provision, either owner can offer to buy the other owner’s interest for a price and on payment terms determined by the owner who makes the offer. Upon receipt of the offer, the other owner must choose whether (i) to accept the offer and sell their interest, or (ii) to buy the offering member’s interest for the same price and on the same payment terms offered to them. 
The theory is that, because the tables can be turned, the first offer will be fair. In practice, however, a push pull provision doesn’t work unless the owners are financially on equal ground. Otherwise, a push pull provision creates an opportunity for the better capitalized owner to offer less than a fair price knowing that the other party lacks the financial resources necessary to purchase the offering owner’s interest and, therefore, they must accept the offer and sell their shares.

Business Entities FAQs