One of the first decisions you make as a business owner is choosing between the different types of business structures for your company. Choosing between different business structures can be confusing. You need a general understanding of how each structure will affect your goals, personal finances, and taxes.
Start by asking yourself these two questions:
- Do you want to own your business with others or go it alone?
- How comfortable are you with being held personally responsible for your business’s debt?
Once you have solid answers to both questions, you can begin to explore your business structure options.
Types of business structures
The business structure you choose rules your personal liability for losses and taxes, so it’s essential to choose the one that’s right for you.
Each of the different types of business structures treats business liability in a different way. A business can be taxed at the personal income level, where only the owner’s earnings are considered. Other business structures are double-taxed at the business and personal income levels.
Some business structure types hold the owner personally responsible for the business’s debts, while others do not. And some businesses are run by multiple owners, so personal liability is divided.
Here are the general descriptions of each business structure:
A sole proprietorship is one of the simplest types of business structures, and has the smallest amount of government regulation. You and your business are not considered separate entities. Sole proprietors pay all taxes on company earnings with personal funds.
If your business is a sinking ship, you and your personal assets go down with it. The business owner is liable for all business’s losses, debt, and liabilities.
A general partnership is a business owned by two or more people. You can begin your partnership with as little as a handshake. Or, start with a formal document drafted by a lawyer (e.g., a partnership agreement).
Partners have equal shares of all profits and losses unless otherwise acknowledged in a partnership agreement. This business structure requires partners to work as co-owners.
Profits generated by general partnerships are only taxed at the personal income level. There is no company-level taxation.
A business owner creates a limited partnership under the state’s limited partnership law. These businesses need at least one general partner and at least one limited partner.
General partners make the business decisions and run the company. They have unlimited personal liability for all business activities.
Limited partners are passive investors with no rights to business decisions. They have no personal liability and only lose their investment if the business fails.
This business structure is good if a family member or friend invests in your business. As a general partner, you have control and responsibility. The limited partner gets ownership without responsibility and risk.
A corporation (C Corp) exists separate from its owners. This means the law treats corporations as an independent legal entity.
Incorporation provides the flexibility to sell ownership stake while protecting the life of the company. A corporate structure is great for expanding businesses that plan on adding or removing shareholders.
Corporations are double-taxed. The company is taxed as a business entity. Each shareholder’s personal income is also taxed.
The qualifications under the tax code greatly limit the size and range of use for S corporations. You can’t have more than 100 shareholders in an S Corp.
S Corps are often preferred by small business owners because there is no double-tax.
Limited liability company
A limited liability company (LLC) is one of the most popular ways to structure a business. It combines features from corporations and partnerships. You enjoy protections reserved for corporations (business and personal liabilities are separate) and tax responsibilities reserved for partnerships (owners have shared responsibility).
LLCs are flexible. LLCs limit personal liability for every member. Taxes pass through to the personal income level, avoiding double corporate taxation. Owners are not personally liable for the business’s debts.
Company names must include the term LLC. Remember, every state treats LLCs differently, so your tax liabilities vary depending on your location.
Choosing between the types of business structures
Be sure to choose the business structure that provides the most benefits to meet your needs. Qualified business law attorneys can help you set up and register your small business.
Limited partnerships, LLCs, and corporations generally need to register with the Secretary of State. You do this in your business’s home state. Check out your state government’s website for more information.
Once you set up your business structure, you need an easy way to track your business transactions. Our small business accounting software uses a simple cash in, cash out recordkeeping system. Try our accounting for small business for free today!
This article was updated from its original publication date (4/23/2013).
Research credit: Amanda Moore, The University of Akron, law student