Rent to own Accounting By John Day, MBA
Author of "Real Life Accounting for Non-Accountants"

What is an "entity"

In business, an entity is referred to as a separate organization unto itself. In accounting, it is an organization for which a set of accounts is kept. Therefore, each entity has financial statements that reflect the financial activity that goes on within it. The entity itself does not use the financial statements because only people can do that. There are several reasons why it is important to understand the distinction between a business entity and the people who run the business.

• To avoid confusion by keeping the business activities separate from personal activities.

• To recognize legal liabilities of the business entity as opposed to those of the individual.

• To recognize the tax obligations of the entity as opposed to the individual.

Now that you understand the distinction between an entity and an individual, let’s look at the various types of business entities.

Types of entities
When starting your new Rent to Own business, one of your first decisions will be to determine what type of business entity will work best for you. There are essentially five types of business entities from which to choose:

• Sole Proprietor

• Partnership

• C Corporation

• S Corporation

• Limited Liability Company (LLC)

Each entity has its particular advantages and disadvantages that you should weigh before choosing. There are too many to cover in this article, but you may find it useful to know a few general characteristics of each one. For instance:

1. Is it a "pass-through" entity?

2. What federal tax form does it use?

3. What is the liability factor?

4. Is it administratively easy or expensive to set up and operate?

Before we start, let’s make sure you know what a "pass-through" entity is. Pass-through means that the entity itself does not pay taxes. It means that the profit or losses of the business are "passed-through" to the owner and reported on his or her personal tax returns.

Sole Proprietorship
For most small RTO businesses, a sole proprietorship is by far the easiest and least expensive to set up and operate. It is a pass-through entity in that the profit or losses from the business are reported on the individual’s personal Form 1040 tax return. Only the income and expenses are reported on Schedule C. No Balance Sheet is required on the tax return. From a legal standpoint, no differentiation is made between the business entity and the individual. This means that if you get sued over a business transaction, your personal assets are at risk.

Partnership
By definition, there must be at least two individuals or entities that own the business. It is a pass-through entity, however, it is required to file its own Form 1065 tax return. The pass-through information (profit or loss) is reported on a K-1 form that is given to the partners to report on their respective tax returns. For partners who are individuals, the K-1 information is reported on Schedule E of their Form 1040 tax return. If the partner is a General Partner then that partner is personally liable up to the amount his percent of ownership represents. A partner can be a "limited" partner who has no say in management decisions. A limited partner is liable only to the amount invested in the company. A Balance Sheet and Income Statement is usually required. A partnership is fairly simple to set up, but a comprehensive partnership agreement should be worked out beforehand.

C Corporation
A C Corporation is more difficult and expensive to set up because of state registration requirements. Most people hire an attorney to initiate the process of obtaining the Articles of Incorporation, establishing the by-laws, issuing stock certificates, writing a stockholder’s agreement, and chairing the first stockholder’s meeting where the new officers are voted in, etc. Annual stockholders’ meetings are required. A Balance Sheet and Income Statement is also required. A C Corporation is not a pass-through entity. It pays its own taxes based on taxable income. C Corporations file a Form 1120 to report taxable information. Stockholders who work in the company are considered employees and must be included in a formal payroll withholding process. Stockholders are not personally at risk, as the corporate entity assumes that responsibility.

S Corporation
An S Corporation has features found in both a C Corporation and a Partnership. It is a pass-through entity like a partnership in that the stockholders receive a K-1 form. The limited liability protection remains the same as the C Corporation. The set up is similarly difficult and expensive as in the C Corporation, and there are the same requirements of structure and accounting as in a C Corporation. The S Corporation files a Form 1120-S to report tax information. S Corporations have special rules that one should be aware of before choosing this organizational form.

Limited Liability Company (LLC)
This form of business organization is fairly new and becoming quite popular. It is easy to set up, like a partnership. However, rules may vary from state to state. Some states require at least two members (rather than stockholders or partners) to establish an LLC. Others, such as California, now allow one member. It is a pass-through entity like a partnership and a sole proprietorship and actually files the Form 1065 as a partnership does or a Schedule C as a sole proprietor does, depending on which form of organization you choose. Liability is limited as in the corporations. One area to be aware of with an LLC is whether there is a "gross receipts fee" as in California. These fees can be a deciding factor when choosing this form of entity.

Choosing
Try to keep your choice as simple and inexpensive as possible when starting out. Keep in mind that as your needs change and you outgrow one entity you can always evolve into another. If you decide you would like to form a corporation or LLC, you can find help by going to my website and clicking on "Accounting Resources". Look for "The Company Corporation" and click on their banner. They offer an inexpensive way to set up an organization that complies with all the state laws and requirements anywhere in the U.S.