When starting a business, you have a lot of decisions to make. One of the most important relates to the type of legal structure you choose.
The decision you make will impact what you pay in taxes and the amount of paperwork your business must do. It also affects your personal liability and your ability to raise funds to help grow your business.
Keep reading to learn the types of business structures available, which will help you find the one best suited for your needs. Being informed is an important part of the business structure building process.
An Overview of Business Structures
The type of business structure you choose will determine several aspects of your business. Choosing the right business structure helps ensure you get the right balance of protection and benefits.
Each of the available business structures treats tax liability differently. For example, some will be taxed at a personal income level or will be double-taxed – both at personal and business income levels.
The most popular types of business structures to choose from are highlighted here.
The sole proprietorship is a common business structure. This is a business that a single person or sole proprietor owns and operates.
This option is ideal if you want to maintain complete control of your business.
A sole proprietorship won’t produce a separate business entity. The business assets and liabilities you have will not be separate.
As a sole proprietor, you will include your personal income and business expenses on your personal tax return. You will also be personally liable for your business’s losses, debt, and liabilities.
This means, if your business goes into debt, then your personal assets will be at risk.
Partnerships are created when two or more people join forces to run a business.
Every partner in the partnership has an equal share in the net losses and profits in the business. As the sole proprietor, every partner will report their income on their own, personal income tax return, and pay their self-employment taxes owed to the IRS.
The partners are also personally liable for the financial obligations and debt of the company. Each partner is also responsible for the actions of the other partners in the partnership.
While it is possible to form a partnership using a handshake or oral agreement, a written agreement is usually the best option if there are disputes or even lawsuits filed between partners.
You can also form something called a limited liability partnership, which combines the benefits of a partnership and an LLC (more about this below).
Limited Liability Company
A limited liability company, which is often called an LLC, was created in 1977. However, the popularity of this business structure has only recently come to focus.
LLCs are considered hybrid entities. They offer some of the best features of corporations and partnerships.
An LLC was originally created to offer business owners the corporations’ protection without any double taxing issues. The losses and earnings of the business passed through to the owners and are added to their personal tax returns.
Another benefit the LLC offers is that there is no limitation on the total number of shareholders that LLCs can have. Also, all LLC members and owners can take a full participatory role in the operation of the business.
If your goal is to set up an LLC, you have to file the articles of organization with the secretary of state in the state where you are planning to conduct business. In some states, it is also necessary to file an operating agreement.
LLCs don’t have perpetual life. Some statutes state that the company is required to dissolve after 30 years. However, the company will typically dissolve if a member retires, quits, or dies.
A corporation offers you the most protection from personal liability. However, a corporation is more complex than other business structures.
If you have plans to expand your business or add shareholders, this is a smart option.
While this is true, corporations require extensive reporting and recordkeeping. You must comply with more tax requirements and regulations than with other business structures.
It’s also worth mentioning that corporations will be double-taxed.
Cases of double taxation occur when you must pay income taxes twice on the same source of income. Your company will be taxed as the business entity and as each shareholder’s personal income with corporations.
Also called an S Corp is a type of corporation where the profits and losses are passed directly to your personal income. They are not subject to any corporate tax rates.
All shareholders must be U.S. citizens. Also, S Corps are not allowed to have over 100 shareholders.
Only the owners or the shareholders of this type of business entity will be taxed. You can avoid cases of double taxation when you elect to operate as an S Corp business entity through the IRS.
Understanding the Different Types of Business Structures
As you can see, there are several types of business structures to choose from. Each one offers pros and cons you must consider. Take some time to consider your business and learn as much as possible to choose the best business entity for your needs. As an entrepreneur or startup founder, you want to ensure that your business is built on a solid foundation for financial success.
Are you searching for more helpful business articles, resources, and guides? If so, make sure to check out some of the other startup blog posts on our Everything Entrepreneur website. We post often to help keep you informed of the latest financial news and trends going on in the business world.