Every great business starts with a great idea. But in order to bring that idea to fruition, the first, and arguably most important, step in forming your business is choosing a business structure that fits you and your business’s needs best. With a myriad of structures to choose from, naturally every business structure has its pros and cons. The most important considerations (and albeit differences) of business structures are: personal liability, tax considerations, and management structure. With that being said, the information below is only a generic overview of the most common business structures, and you should consult an attorney and/or a CPA to determine which business structure would best suit your business needs!
A sole proprietorship is defined as an individual owning an unincorporated business by himself or herself. A sole proprietorship is much simpler and quicker to form and doesn’t typically require any state filings with dues or fees. A sole proprietor has the utmost freedom in terms of management structure since they are the sole owner and thus inseparable from the business. With that being said, a sole proprietor is also “on the hook” personally for all of the business’s debts and obligations, so their personal assets are reachable by creditors. The income from the sole proprietor’s business is treated as personal income, so the business itself is not taxed separately. Many people find it helpful to start as a sole proprietorship and change to an LLC or S Corporation after they’ve decided to scale their business more.
A partnership is formed when two or more individuals join together to carry on a business for-profit as co-owners. Many states vary on the requirement of state filings, but most require that you register your business name and obtain a state tax ID number. Often times close friends and family members will decide to go into business together, so they form a general partnership. A general partnership operates structurally similar to a sole proprietorship, just with the addition of at least one more person to the business. Partners will share profits and losses amongst each other, and each partner is also personally liable for any taxes, lawsuits, or liabilities incurred by the business. Finally, partners are generally responsible for reporting income and losses on their own individual tax return. Partnerships, like sole proprietorships, are less burdensome to form and provide you with the advantage of having another person’s knowledge and skillset to collaborate with.
Limited Liability Company (LLC)
An LLC is most typically described as having the tax benefits of a partnership/sole proprietorship, but the limited personal liability of a corporation (which is why it tends to be the most popular). An LLC still maintains flexibility in management structure, but also creates a separation from the individual owner(s) and the business. There are also more formalities involved with an LLC, such as state filings (and a fee) with your state’s respective Secretary of State, along with annual reports in some states. While not always required, Operating Agreements (or Owner’s Agreements) are essential to LLCs in maintaining limited personal liability, as this protection is not automatic and requires the observance of certain formalities. [Read more about Operating Agreements here] While LLCs require more paperwork to get started, they do offer a “best of both worlds” scenario to certain businesses
An S Corp is another hybrid business entity which combines the tax benefits of a partnership/sole proprietorship, but also limits personal liability and permits the owners to actually own stock of the business. The management structure of an S Corp is a bit more complex and includes shareholders, the election of a board of directors, and appointment of officers. S Corps require state filings for formation, but unlike an LLC, S Corps are also required to file Articles of Incorporation and corporate minutes with their respective states. Another defining feature of the S Corp is that it must pay a reasonable salary to all shareholders and officers/employees, whether or not the business is profitable. S Corps tend to be more appealing to small businesses looking to scale to the next level, as investors are more drawn to this structure due to the ability to sell or transfer stock.
Corporation (C Corp)
A corporation is a business structure that can be comprised of individuals or a company and limits personal liability. Corporations are unique in that they have the ability to own assets, enter into contracts, and maintain/defend a lawsuit. This type of business structure requires shareholders, a board of directors, and officers. Corporations are publicly traded companies and have easier access to larger investors. Stricter formalities are required of corporations such as filing of Articles of Incorporation, Bylaws, corporate minutes, formal board meetings, stock distribution reporting, etc. C Corps are taxed twice, which means the shareholders (owners) are taxed on the salary they are required to be paid and the business is also taxed on the profits it has made. Corporations are best for much larger scale businesses looking to grow their business even more.
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