Choosing The Right Business Structure
Small businesses make up 99.9% of all businesses in the United States. In one big number, that equates to more than 30 million businesses! The structure of your business impacts taxes, fundraising, paperwork, and personal liability. Select a business structure prior to state registration, and obtain a tax ID number as well as licenses and permits. Be cautious, as location-based restrictions could result in unintended dissolution and tax consequences. If you have any questions about what is best for your business, seek advice from business counselors, attorneys, and accountants for guidance.
If you are engaged in business activities but have not registered as any other kind of business, you are automatically considered a sole proprietorship. Sole proprietorships are easy to form and give you complete control over your business.
However, sole proprietorships do not create a separate business entity, so your personal assets and liabilities are not separate from your business assets and liabilities. As a result, you can be held personally liable for your business's debts and obligations. While you can still get a trade name, it may be difficult to raise money because you can't sell stock and banks are hesitant to lend to sole proprietorships.
If you have a low-risk business and want to test your business idea before forming a more formal business, a sole proprietorship can be a good choice. Keep in mind that while you can convert to a different business structure in the future, there may be restrictions based on your location, which could result in tax consequences and unintended dissolution, among other complications. Consulting with business counselors, attorneys, and accountants can help you make the best decision for your business.
Partnerships are a simple way for multiple owners to run a business together. Two types of partnerships exist: limited partnerships (LP) and limited liability partnerships (LLP).
Limited partnerships have one general partner who bears unlimited liability, while all other partners have limited liability. Those partners with limited liability may have restricted control over the business, which is documented in a partnership agreement. Personal tax returns receive profit pass-throughs, and the general partner — i.e., the partner without limited liability — must also pay self-employment taxes.
Limited liability partnerships work much like limited partnerships, but grant limited liability to every owner. LLPs safeguard each partner from the partnership's debts, protecting them from being responsible for other partners' actions.
Partnerships can be ideal for businesses with multiple owners, professional groups (such as lawyers), and those who want to test their business concept before creating a more formal business structure.
Limited Liability Companies
The Limited Liability Company (LLC) combines the benefits of a corporation and partnership business structure.
An LLC provides personal liability protection in most instances, safeguarding personal assets such as savings accounts, vehicles, and homes from legal action and bankruptcy.
By separating personal assets from business assets, LLCs provide a layer of personal asset protection. Profits and losses pass through to personal income, which can reduce corporate tax. However, LLC members are self-employed and must contribute to self-employment tax for Medicare and Social Security.
In some states, LLCs have a limited life. When a member joins or leaves, the LLC may need to be dissolved and re-formed unless an agreement for buying, selling, or transferring ownership exists.
LLCs are ideal for medium- or higher-risk businesses, owners with significant personal assets, and those seeking lower tax rates than with a corporation. They are an extremely favorable entity type for most businesses.
A C corp, or corporation, is a distinct legal entity separate from its owners that can make a profit, be taxed, and be held legally liable. It provides strong personal liability protection to its owners, but its formation cost is higher compared to other structures, and requires more extensive record-keeping, operational processes, and reporting.
Unlike other structures, corporations pay income tax on their profits and corporate profits can be taxed twice - first, when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns. Shareholders can leave the company or sell their shares, without interrupting the corporation's business.
Corporations have a significant advantage in raising capital as they can raise funds through the sale of stock, which can also attract employees. Corporations are a suitable choice for medium to high-risk businesses, those who need to raise funds, and businesses planning to become publicly traded or sold.
An S corporation, or S corp, is a unique type of corporation that aims to avoid the double taxation that regular C corps face. S corps allow profits and losses to be passed through directly to the owners' personal income without having to go through corporate tax rates.
While most states recognize S corps in the same way as the federal government, not all states tax them equally. Some states tax S corps on profits above a certain limit, while others don't acknowledge the S corp election at all and treat the business as a C corp.
To obtain S corp status, companies must register with the IRS, which differs from registering with their state. Visit the IRS website to verify eligibility requirements. S corps are subject to the strict operational and filing procedures of a C corp.
Similar to C corps, S corps have an independent existence. If a shareholder leaves the company or sells their shares, the S corp can keep operating without much disturbance.
If a business qualifies, an S corp may be a great choice instead of a C corp.
A benefit corporation, sometimes called a B corp, is a for-profit corporation recognized by a majority of U.S. states. B corps are different from C corps in purpose, accountability, and transparency, but aren't different in how they're taxed.
B corps are driven by both mission and profit. Shareholders hold the company accountable to produce some sort of public benefit in addition to a financial profit. Some states require B corps to submit annual benefit reports that demonstrate their contribution to the public good.
There are several third-party B corp certification services, but none are required for a company to be legally considered a B corp in a state where the legal status is available.
Close corporations are similar to B corps but have a less formal corporate structure that is suited for smaller companies. Unlike typical corporations that follow strict formalities, close corporations shed most of these formalities.
The rules of close corporations vary from state to state, but in most cases, shares cannot be traded publicly. These corporations can be managed by a small group of shareholders without the need for a board of directors. As such, close corporations can be a good choice for smaller businesses that do not need to follow formal corporate structures.
Nonprofit corporations are entities formed to carry out charitable, educational, religious, literary, or scientific purposes that benefit the public. As these corporations work for the greater good, they can receive tax-exempt status, which implies that they need not pay state or federal income taxes on any profits they make.
To attain tax-exempt status, nonprofits must follow a separate process of filing with the IRS and not merely register with their state.
Similar to a C corp, nonprofits must adhere to strict organizational guidelines, and they need to follow specific rules on what they do with any earnings they make. For instance, nonprofits can't distribute profits to members or political campaigns.
Commonly referred to as 501(c)(3) corporations, nonprofits are granted tax-exempt status based on the section of the Internal Revenue Code that is most frequently employed.
A cooperative business or organization is distinctively owned and operated for the betterment of those availing its services. The members who use its services and benefit from it also known as user-owners receive the profits and earnings generated by the cooperative. The cooperative is primarily managed by an elected board of directors and officers, while the regular members have the power to vote and direct the cooperative's course of action. The cooperative structure allows members to purchase shares, and every member's vote has equal weight regardless of the number of shares they possess.
Combining Business Structures To Suit Your Needs
Designations such as S corp and nonprofit, which are generally associated with business structures, are primarily related to tax status. However, it is important to note that LLCs can also opt to be taxed as an S corp, C corp, or a nonprofit.
While these non-standard structures are less common and often more complicated to establish, they can provide unique benefits. If you are considering one of these options, it is advisable to seek guidance from a business counselor or an attorney to help you make an informed decision that best suits your needs. They can help you navigate the legal and financial complexities associated with non-standard business structures and ensure compliance with applicable laws and regulations.
Compare business structures
Please note that the characteristics of business structures outlined below are general, and rules concerning ownership, liability, taxes, and filing requirements can differ by state. The table provided is for informational purposes only and should not be taken as a comprehensive guide. It's advisable to consult with a business tax expert to determine your company's particular requirements.