You’ll need to choose your business structure before you register your business. The business structure you choose influences everything from day-to-day operations to taxes and how much of your personal assets are at risk. You should choose a business structure that gives you the right balance of legal protections and benefits. Choose wisely because converting to another structure after the fact can be pricey, and there may be restrictions in some states.
Here are the most common business structures and their benefits:
Sole Proprietorship – Easy to form. Gives you complete control of your business. Do not produce a separate business entity, meaning your business assets and liabilities are not separate from your personal assets and liabilities, and you can be held personally liable for the debts and obligations of the business. Able to get a trade name. Hard to raise money because you can’t sell stock, and banks are hesitant to lend to sole proprietorships. It can be a good choice for low-risk businesses.
Partnerships – Simplest structure for two or more people to own a business together. There are two common kinds of partnerships: limited partnerships (LP) and limited liability partnerships (LLP). Partnerships can be a good choice for businesses with multiple owners, professional groups (like attorneys), and groups who want to test their business idea before forming a more formal business.
Limited Partnerships – One general partner with unlimited liability, and all other partners have limited liability. Profits are passed through to personal tax returns, and the general. Must also pay self-employment taxes.
Limited Liability Partnerships – Similar to limited partnerships, but give limited liability to every owner. LLP protects each partner from debts against the partnership, and they won’t be responsible for the actions of other partners.
Limited liability company (LLC) – An LLC lets you take advantage of the benefits of both the corporation and partnership business structures.
LLCs protect you from personal liability in most instances. Your personal assets won’t be at risk if your LLC faces bankruptcy or lawsuits.
Profits and losses can get passed through to your personal income without facing corporate taxes. However, members of an LLC are considered self-employed and must pay self-employment tax toward Medicare and Social Security.
LLCs are a great choice for medium- or higher-risk businesses, owners with significant personal assets they want to be protected, and owners who want to pay a lower tax rate than they would with a corporation.
C-Corp – A legal entity that’s separate from its owners. Corporations can make a profit, be taxed, and can be held legally liable. While corporations offer the strongest protection to their owners from personal liability, the cost of forming a corporation is higher than other structures. Corporations also require more extensive record-keeping, operational processes, and reporting.
Corporations pay income tax on their profits. In some cases, corporate profits are taxed twice — first, when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns.
Corporations have a completely independent life separate from their shareholders. If a shareholder leaves the company or sells his or her shares, the C-Corp can continue doing business relatively undisturbed.
Corporations have an advantage when it comes to raising capital because they can raise funds through the sale of stock, which can also be a benefit in attracting employees.
Corporations can be a good choice for medium- or higher-risk businesses, those that need to raise money and businesses that plan to “go public” or eventually be sold.
S-Corp – An S corporation, sometimes called an S-Corp, is a special type of corporation that’s designed to avoid the double taxation drawback of regular C-Corps. S-Corps allow profits, and some losses, to be passed through directly to owners’ personal income without ever being subject to corporate tax rates.