Table of Contents
Understanding Business Structure & Entity- Glossary, Terminology
For a living, we engage in different activities to earn income and meet our daily needs. Starting and running a business is one of the ways people create income, build financial stability, and achieve their financial goals.
Before starting a business, it is important to understand what a business is, how it operates, and what legal and structural options are available. Understanding these basics helps business owners make informed decisions about how they want to establish and operate their business.
Every business can have a different legal structure and entity type depending on its ownership, operations, liability, tax considerations, and future goals. Understanding these options helps determine which structure may be appropriate for a particular business.
For accountants and bookkeepers, understanding business and entity terminology is equally important. It helps them understand who owns the business, how ownership and capital are recorded, and how business transactions should be treated for accounting and tax purposes.
Terms such as LLC, S Corporation, C Corporation, partnership, owner’s draw, distribution, capital contribution, shareholder, member, and retained earnings provide the foundation for understanding how a business is organized and how its financial activities are recorded and reported.
Understanding Business Structures and Entity Types
1. Business
A business is an activity or organization created to provide products or services in exchange for income or profit.
Before starting a business, the owner needs to understand its purpose, operations, legal requirements, and financial responsibilities.
The business structure determines how the business is owned, managed, taxed, and legally operated.
2. Business Structure
A business structure is the legal framework used to organize and operate a business.
Common U.S. structures include Sole Proprietorship, Partnership, LLC, S Corporation, and C Corporation.
The structure affects taxation, ownership, liability, reporting requirements, and how profits are distributed.
3. Business Entity
A business entity is a legally recognized organization created to conduct business activities.
Depending on the structure, the entity may have its own legal identity separate from its owners.
Choosing the appropriate entity helps determine legal liability, taxation, ownership, and compliance requirements.
4. Sole Proprietorship
A sole proprietorship is a business owned and operated by one individual.
The owner and business are generally not legally separate, meaning the owner may be personally responsible for business obligations.
Business income and expenses are generally reported on the owner’s individual tax return, often using Schedule C.
5. Partnership
A partnership is a business owned by two or more individuals or entities that agree to operate the business together.
Partners generally share profits, losses, responsibilities, and decision-making according to their partnership agreement.
A partnership typically files an information tax return, while income and losses generally pass through to the partners.
6. Limited Liability Company (LLC)
An LLC is a business structure that generally provides owners with limited personal liability for business obligations.
An LLC can have one or multiple owners, known as members.
For federal tax purposes, an LLC may receive different tax treatment depending on its ownership and elections.
7. Single-Member LLC
A single-member LLC is an LLC owned by one person or owner.
For federal income tax purposes, it is generally treated as a disregarded entity unless the owner elects corporate tax treatment.
The owner’s business activity is commonly reported on the owner’s tax return, depending on the nature of the business.
8. Multi-Member LLC
A multi-member LLC has two or more owners, known as members.
By default, a domestic multi-member LLC is generally treated as a partnership for federal income tax purposes.
The LLC’s income and expenses are generally reported through the entity and allocated to its members.
9. Corporation
A corporation is a legal business entity that is generally separate from its owners.
It can own assets, enter into contracts, incur liabilities, and conduct business in its own name.
Corporations generally provide limited liability protection but have additional formation, reporting, and compliance requirements.
10. C Corporation
A C Corporation (C Corp) is a corporation that is generally taxed as a separate taxpayer for federal income tax purposes.
The corporation generally pays tax on its taxable income, while shareholders may also pay tax when dividends are distributed.
C Corporations are commonly used by businesses seeking outside investment or a corporate ownership structure.
11. S Corporation
An S Corporation (S Corp) is generally a corporation or eligible entity that has elected special federal tax treatment under Subchapter S.
Income, deductions, and certain other tax items generally pass through to shareholders rather than being taxed at the corporate level.
S Corporations also have specific eligibility, shareholder, payroll, and tax filing requirements.
12. Shareholder
A shareholder is an individual or entity that owns shares of a corporation.
Shareholders generally have an ownership interest in the corporation and may have rights related to voting and distributions.
The percentage of shares owned can determine a shareholder’s ownership interest and voting power.
13. Member
A member is an owner of an LLC.
An LLC may have one member or multiple members, depending on its ownership structure.
Members may contribute money, property, or services to the business and generally share in profits and losses according to the operating agreement.
14. Partner
A partner is an owner of a partnership.
Partners may contribute capital, property, or services and share in the partnership’s profits, losses, and responsibilities.
The partnership agreement generally establishes the rights, responsibilities, and ownership interests of the partners.
15. DBA — Doing Business As
A DBA, or Doing Business As, is a name under which a business operates that is different from its legal name.
For example, an owner may legally operate under one name but use a different name when dealing with customers.
DBA registration requirements vary by state and local jurisdiction.
16. EIN — Employer Identification Number
An EIN is a federal tax identification number issued by the IRS to identify a business for tax purposes.
Businesses may use an EIN when filing tax returns, hiring employees, opening business bank accounts, and handling certain financial transactions.
It is commonly considered the business equivalent of a federal tax identification number.
17. Operating Agreement
An operating agreement is a document that establishes how an LLC will be owned and managed.
It may describe ownership percentages, member responsibilities, profit distributions, voting rights, and procedures for changes in ownership.
It helps establish clear rules for operating the LLC and managing disagreements among members.
18. Partnership Agreement
A partnership agreement is a legal document that defines how a partnership will operate.
It may specify each partner’s ownership, responsibilities, contributions, profit-sharing arrangements, and decision-making rights.
A clear agreement helps establish expectations between partners and reduce potential disputes.
19. Articles of Organization
Articles of Organization are formation documents generally filed with a state to create an LLC.
They typically provide basic information about the LLC, such as its name and registered agent.
The exact requirements and terminology vary by state.
20. Articles of Incorporation
Articles of Incorporation are documents generally filed with a state to legally establish a corporation.
They usually include basic information such as the corporation’s name, purpose, and authorized shares.
Once approved, the corporation becomes a legally recognized entity under state law.
21. Registered Agent
A registered agent is an individual or authorized business designated to receive official legal and government documents on behalf of a business entity.
The registered agent generally maintains a physical address in the state where the entity is registered.
Corporations and LLCs commonly need a registered agent to remain compliant with state requirements.
22. Ownership Interest
Ownership interest represents a person’s or entity’s share of ownership in a business.
For an LLC, ownership is generally represented through membership interests, while corporations generally use shares of stock.
Ownership percentages can affect voting rights, profit distributions, and allocation of certain business interests.
23. Limited Liability
Limited liability generally means that owners are not personally responsible for all business debts and obligations simply because they own the business.
This protection is commonly associated with LLCs and corporations.
However, limited liability is not absolute and may have exceptions under applicable law.
24. Pass-Through Entity
A pass-through entity generally does not pay federal income tax at the entity level on its ordinary business income in the same manner as a C Corporation.
Instead, certain income, deductions, and other tax items generally pass through to the owners.
Partnerships, S Corporations, and many LLCs receive pass-through tax treatment.
25. Tax Election
A tax election is a formal choice made by a business to receive a particular tax treatment.
For example, an eligible LLC may elect to be taxed as a corporation or, if eligible, an S Corporation.
The election can affect tax reporting, payroll requirements, and how business income is taxed.
26. Business License
A business license is an authorization required by a government authority to conduct certain business activities.
Requirements depend on the business type, location, industry, and applicable state or local rules.
A business may need multiple licenses or permits depending on its activities.
27. State of Formation
The state of formation is the state where an LLC or corporation is legally created by filing the required formation documents.
A business may conduct operations in other states after meeting applicable registration requirements.
The state of formation can affect legal, reporting, and administrative requirements.
28. Foreign Qualification
Foreign qualification is the process through which a business entity registers with a state other than its state of formation to conduct business there.
For example, a corporation formed in Delaware may need to register in Texas if it conducts sufficient business there.
The exact requirements depend on the laws of each state.
29. Dissolution
Dissolution is the formal process of ending a business entity’s legal existence.
It generally involves settling debts, handling remaining assets, completing required filings, and closing the entity according to applicable laws.
The process varies depending on the entity type and state.
30. Business Compliance
Business compliance refers to following the legal, tax, financial, licensing, and reporting requirements that apply to a business.
These requirements may include tax filings, annual reports, payroll compliance, licenses, and maintaining business records.
Proper compliance helps a business remain in good standing and avoid penalties.
Tax & U.S. Entity Tax Classification
A. Understanding Tax
1. Tax
Tax is a mandatory amount collected by the government from individuals and businesses.
Taxes may be based on income, purchases, property, employment, or specific business activities.
Tax revenue is used to fund government operations and public services.
2. Why Do We Pay Tax?
Individuals and businesses pay taxes to provide revenue for government activities and public services.
Tax revenue supports areas such as infrastructure, public safety, education, government administration, and other programs.
The type and amount of tax depend on the taxpayer’s circumstances and applicable laws.
3. Taxpayer
A taxpayer is an individual, business, or other entity that has tax obligations under applicable law.
A taxpayer may be responsible for calculating, reporting, withholding, or paying taxes.
Businesses can have several different types of tax obligations depending on their activities and structure.
B. Types of Tax in the U.S.
4. Income Tax
Income tax is a tax imposed on taxable income earned by individuals and businesses.
Individuals may pay tax on wages, business income, investment income, and other taxable income.
Businesses may also have federal or state income tax obligations depending on their entity classification.
5. Federal Income Tax
Federal income tax is imposed by the U.S. federal government on taxable income.
Individuals generally report federal income tax on their individual tax returns, while businesses use the tax return applicable to their entity classification.
6. State Income Tax
State income tax is imposed by individual states on taxable income under their respective state laws.
Not every state imposes an individual income tax, and business taxation varies by state.
A business operating in multiple states may have tax obligations in more than one state.
7. Self-Employment Tax
Self-employment tax generally applies to individuals who have net earnings from self-employment.
It primarily consists of Social Security and Medicare taxes for self-employed individuals.
Self-employment tax is separate from regular federal income tax.
8. Payroll Tax
Payroll taxes are taxes associated with employee wages and employment.
They generally include Social Security and Medicare taxes, along with federal unemployment tax and applicable state payroll taxes.
Employers are generally responsible for withholding certain employee taxes and paying applicable employer taxes.
9. Sales Tax
Sales tax is generally imposed by states and local governments on certain sales of taxable goods and services.
A business that makes taxable sales may be required to collect sales tax from customers and remit it to the appropriate tax authority.
Sales tax rules and rates vary significantly by state and locality.
10. Property Tax
Property tax is generally imposed by state and local governments on certain real and personal property.
Real estate such as land and buildings is commonly subject to property tax.
Businesses that own taxable property may have property tax reporting and payment obligations.
11. Excise Tax
Excise tax is a tax imposed on specific goods, services, or activities rather than on general income.
Examples can include certain fuel, transportation, tobacco, and other specially taxed products or activities.
The tax may be included in the price or separately charged, depending on the applicable rules.
12. Estate Tax
Estate tax is a tax that may apply to the transfer of a person’s estate after death.
It is generally based on the value of the estate after applying applicable exclusions, deductions, and other rules.
Federal estate tax rules are separate from state estate tax rules.
13. Gift Tax
Gift tax applies to certain transfers of property or money made during a person’s lifetime.
Federal gift tax rules generally apply when a person transfers assets without receiving adequate value in return.
Various exclusions and exemptions can affect whether gift tax is actually due.
14. Franchise Tax
A franchise tax is a state-level tax imposed on certain businesses for the privilege of conducting business or maintaining an entity in that state.
It may apply even when a business does not owe traditional state income tax.
Rules, calculation methods, and filing requirements vary by state.
15. Use Tax
Use tax generally applies when taxable goods are purchased without paying applicable sales tax and are then used, stored, or consumed in a jurisdiction that imposes use tax.
It is intended to address situations where sales tax was not collected at the time of purchase.
Businesses may have use tax obligations on certain purchases
Accounting fundamentals and bookkeeping terminology
1. Bookkeeping
What it is: Bookkeeping is the systematic recording, classification, and maintenance of a business’s financial transactions, including sales, purchases, receipts, payments, and payroll.
Why it is used: It maintains organized financial records and provides reliable data for reconciliations, financial statements, tax preparation, and management decisions.
Financial statement effect: Bookkeeping records provide the underlying data used to prepare the Balance Sheet, Income Statement, and Statement of Cash Flows.
U.S. GAAP definition / treatment: Bookkeeping is not a separately defined U.S. GAAP accounting standard. It is the recordkeeping process that supports compliance with applicable GAAP requirements for recognition, measurement, presentation, and disclosure.
In brief: Bookkeeping records transactions; U.S. GAAP guides how relevant financial information is reported.
2. Accounting
What it is: Accounting is the process of identifying, recording, classifying, summarizing, analyzing, and reporting financial information.
Why it is used: It helps business owners, management, investors, lenders, and other users understand financial performance and financial position.
Financial statement effect: Accounting determines how transactions are reflected in assets, liabilities, equity, revenue, expenses, gains, losses, and cash flows.
U.S. GAAP definition / treatment: U.S. GAAP provides authoritative financial reporting requirements for applicable transactions and events. The accounting treatment depends on the relevant guidance in the FASB Accounting Standards Codification (ASC).
In brief: Accounting turns transaction records into meaningful financial information.
3. U.S. GAAP
What it is: U.S. GAAP stands for Generally Accepted Accounting Principles—the authoritative accounting requirements used for financial reporting in the United States.
Why it is used: It establishes consistent requirements for preparing financial statements and helps users evaluate financial information.
Financial statement effect: GAAP affects how financial statement items are recognized, measured, classified, presented, and disclosed.
U.S. GAAP definition / treatment: The FASB Accounting Standards Codification is the primary source of authoritative GAAP for nongovernmental entities, subject to applicable SEC requirements. FASB’s Conceptual Framework explains underlying concepts but is not itself authoritative GAAP. FASB standards.
In brief: U.S. GAAP provides the authoritative requirements for applicable financial reporting.
4. Accounting Transaction
What it is: An accounting transaction is a business activity or event that affects, or may need to be evaluated for, an entity’s financial records.
Why it is used: Identifying transactions helps accountants determine which events need to be recorded and how they should be classified.
Financial statement effect: A transaction may change assets, liabilities, equity, revenue, expenses, or cash flows.
U.S. GAAP definition / treatment: Not every business event is recorded immediately or in the same way. Recognition depends on the applicable GAAP requirements, including the nature of the event and whether recognition criteria are met.
In brief: Identify the transaction first, then determine its accounting treatment.
5. Chart of Accounts (COA)
What it is: A chart of accounts is an organized list of the accounts used in a company’s accounting system.
Why it is used: It standardizes transaction classification and makes financial reporting easier to organize and review.
Financial statement effect: Account classifications determine where balances appear in the Balance Sheet, Income Statement, and other reports.
U.S. GAAP definition / treatment: A chart of accounts is an internal accounting structure, not a prescribed universal GAAP list. The account categories and reporting classifications should support the applicable financial reporting requirements.
In brief: The chart of accounts determines where transactions are recorded.
6. General Ledger (GL)
What it is: The General Ledger is the main accounting record containing individual accounts and their posted debit and credit activity.
Why it is used: It provides the account-level detail used to review balances, prepare trial balances, reconcile accounts, and produce financial statements.
Financial statement effect: General Ledger balances feed into the financial statements.
U.S. GAAP definition / treatment: The General Ledger is an accounting record rather than a separate GAAP financial statement. Its balances must reflect transactions accounted for under applicable GAAP when the financial statements are presented as GAAP-compliant.
In brief: The GL is the central record of a company’s account balances and activity.
7. Journal Entry
What it is: A journal entry records a transaction or adjustment using debit and credit entries.
Why it is used: It documents how a transaction affects the accounting records and provides an audit trail.
Financial statement effect: Depending on the accounts used, a journal entry may affect the Balance Sheet, Income Statement, or both.
U.S. GAAP definition / treatment: Journal entries are a recording mechanism, not a specific GAAP standard. The accounts, amounts, and timing must follow the applicable accounting requirements.
In brief: A journal entry records the accounting impact of a transaction.
8. Debit
What it is: A debit is an entry recorded on the left side of a double-entry accounting account.
Why it is used: Debits record increases or decreases depending on the account type.
Financial statement effect: Debits generally increase assets and expenses, while they generally decrease liabilities, equity, and revenue.
U.S. GAAP definition / treatment: Debit is a bookkeeping convention, not a standalone GAAP recognition rule. The correct debit depends on the nature of the transaction and the accounts involved.
In brief: A debit’s effect depends on the account being debited.
9. Credit
What it is: A credit is an entry recorded on the right side of a double-entry accounting account.
Why it is used: Credits record increases or decreases depending on the account type.
Financial statement effect: Credits generally increase liabilities, equity, and revenue, while they generally decrease assets and expenses.
U.S. GAAP definition / treatment: Credit is a bookkeeping convention. It does not by itself determine whether a transaction qualifies for recognition under U.S. GAAP.
In brief: A credit’s effect depends on the account being credited.
10. Double-Entry Accounting
What it is: Double-entry accounting records each transaction through corresponding debit and credit entries.
Why it is used: It maintains balanced accounting records and supports the accounting equation.
Financial statement effect: It helps maintain the relationship between assets, liabilities, equity, revenue, and expenses.
U.S. GAAP definition / treatment: Double-entry bookkeeping is a widely used accounting system, not a standalone GAAP financial reporting standard. The resulting financial information must still comply with applicable GAAP requirements.
In brief: Total debits must equal total credits for a properly recorded journal entry.
11. Accounting Equation
What it is: The accounting equation expresses the relationship between a business’s assets, liabilities, and equity.
Why it is used: It helps verify the fundamental structure of the accounting records.
Financial statement effect: It connects the Balance Sheet’s asset balances with liabilities and equity.
U.S. GAAP definition / treatment: The equation is a foundational accounting relationship rather than a separate GAAP standard. Specific asset, liability, and equity recognition and measurement rules determine the amounts reported.
In brief: Assets = Liabilities + Equity.
12. Accounting Period
What it is: An accounting period is the time span covered by financial reports, such as a month, quarter, or year.
Why it is used: It allows businesses to measure financial performance and position over defined periods.
Financial statement effect: Revenue, expenses, assets, and liabilities are reported in the periods required by the applicable accounting rules.
U.S. GAAP definition / treatment: U.S. GAAP financial reporting uses defined reporting periods. Recognition and cutoff requirements determine which transactions belong in each period.
In brief: An accounting period defines the timeframe covered by a report.
13. Fiscal Year
What it is: A fiscal year is a 12-month reporting period that does not necessarily follow the calendar year.
Why it is used: It may align reporting with a business’s operating cycle, budgeting, or industry practices.
Financial statement effect: It determines the period covered by annual financial statements.
U.S. GAAP definition / treatment: Fiscal-year reporting is permitted when applicable requirements are followed. Tax-year rules are separate and must also be considered for tax reporting.
In brief: A fiscal year is a business’s chosen or required annual reporting period.
14. Accounting Estimate
What it is: An accounting estimate is an amount determined using judgment and available information when the exact value is uncertain.
Why it is used: Many accounting balances depend on estimates of future outcomes or values that cannot be known precisely.
Financial statement effect: Estimates may affect receivables, depreciation, warranties, contingencies, and other balances.
U.S. GAAP definition / treatment: Applicable GAAP guidance governs the estimate. Changes in estimates are generally accounted for prospectively under the relevant requirements, while corrections of errors follow different rules.
In brief: Estimates use reasonable methods and available evidence to determine uncertain amounts.
15. Accounting Policy
What it is: An accounting policy is a specific principle, basis, convention, rule, or practice an entity uses to prepare its financial statements.
Why it is used: It promotes consistent accounting and documents how the company applies relevant requirements.
Financial statement effect: Policies influence recognition, measurement, presentation, and disclosure.
U.S. GAAP definition / treatment: Accounting policies must comply with applicable GAAP. Changes in accounting principles are subject to specific requirements for justification, application, and disclosure.
In brief: An accounting policy explains the accounting approach a business follows.