Congratulations!  You have decided to step out and start your own business.  There are so many choices to make in the beginning and you are probably wondering where to start.  Or you may have been in business for a few years and want to make sure that you are set up under the correct entity type.    One of the first steps in starting your business is to decide what type of business structure is best for you and your business goals.  The structure you choose will affect the way you file and pay taxes, operate your business, and personal liability.  There are five main business structures: 

• What is Sole Proprietorship?
• What is Partnership?
• What is S corporation?
• What is C corporation?
• What is LLC – Limited liability company?

     Let’s dive a little deeper into each one so you can have a more clear understanding of which structure works best for you. 

 

What is Sole Proprietorship?

A sole proprietorship is one of the simplest and most common structures for entrepreneurs.  It is an unincorporated business with only one owner, which is you.  You do not have to register your business with your state.  Also, there is no legal distinction between you and the business.  You as the owner are entitled to all profits from the business.  On the other side though, you are also liable for all debts and losses.    

Pros: 

1. Simplicity of Formation: Sole proprietorships are the simplest and least expensive business structure to establish. There are minimal legal formalities, and typically, no formal registration process is required.
2. Direct Control: As the sole owner, you have complete control over all business decisions and operations, allowing for quick decision-making and flexibility in adapting to market changes.

Cons: 

1. Unlimited Liability: The owner of a sole proprietorship is personally liable for all business debts and obligations. This means that personal assets, such as savings and property, are at risk if the business faces lawsuits or financial difficulties.
2. Limited Access to Capital: Sole proprietors may find it challenging to access capital since they are personally responsible for obtaining financing. Banks and investors may be hesitant to lend money to sole proprietorships due to the lack of business structure and limited collateral.

 

What is Partnership?

A partnership is a business owned by two or more people.  This entity may be best if you are starting a business with someone else.  Partners in a partnership share profits, operation responsibilities, and liabilities.  Since there is more than one owner, there is always someone there to bounce ideas back and forth with.   

Pros: 

1. Ease of Formation: Partnerships are relatively easy and inexpensive to form compared to corporations. They typically require less paperwork and formalities.
2. Pass-Through Taxation: Like LLCs, partnerships are usually taxed as pass-through entities, meaning the profits and losses are passed through to the partners’ personal tax returns, avoiding double taxation.

Cons: 

1. Unlimited Liability: In a general partnership, partners have unlimited personal liability for the debts and obligations of the business. This means that personal assets can be at risk if the business faces lawsuits or financial difficulties.
2. Dependency on Partners: Partnerships rely on the cooperation and trust of all partners. If one partner becomes unreliable or leaves the partnership, it can negatively impact the business.

 

What is S Corporation?

S Corporations are corporations that pass income, losses, and deductions to the shareholders.  In order to make an election to be taxed as an S Corporation, the business owner must form an LLC or be incorporated with their state.  Once the LLC or incorporation is formed, the shareholder or shareholders, make the election to be an S Corporation.  S Corporation shareholders and officers who perform services for the company are considered employees and must receive a W-2.   There can be a single owner or up to 100 owners. 

Pros: 

1. Limited Liability: Similar to LLCs and partnerships, S Corporations offer limited liability protection to shareholders, meaning their personal assets are typically shielded from business debts and liabilities.
2. Pass-Through Taxation: S Corporations enjoy pass-through taxation, meaning the corporation’s profits and losses are passed through to shareholders’ personal tax returns. This can potentially lead to tax savings compared to double taxation faced by traditional C Corporations.

Cons: 

1. Restrictions on Ownership: S Corporations are subject to strict eligibility requirements, including limitations on the number and type of shareholders, as well as restrictions on foreign ownership. This can limit flexibility in structuring ownership and raising capital.
2. Complexity in Tax Planning: While S Corporations offer tax advantages, they can also add complexity to tax planning, especially regarding distributions, salaries, and other tax-optimization strategies. Shareholders may need to work closely with tax advisors to maximize tax benefits while staying compliant with IRS regulations.

 

What is C Corporations?

A C corporation is a legal entity that is taxed separately from its owners.  It is independent of the owners/shareholders.  This type of entity is best for larger, more established companies and is more complicated to set up.  It is easier to get funding if your company is a C Corporation.  

Pros: 

1. Limited Liability: Shareholders of a C Corporation typically have limited liability, meaning their personal assets are protected from the debts and liabilities of the corporation. This is one of the most significant advantages of the corporate structure.
2. Separate Legal Entity: C Corporations are distinct legal entities separate from their owners, which can provide additional protection against personal liability and allow for perpetual existence, regardless of changes in ownership.

Cons: 

1. Double Taxation: One of the most significant drawbacks of C Corporations is double taxation. Corporate profits are taxed at the corporate level, and then dividends distributed to shareholders are taxed again at the individual level, leading to potentially higher overall tax liabilities.
2. Complexity and Compliance Costs: C Corporations are subject to more complex legal and regulatory requirements compared to other business structures, resulting in higher administrative and compliance costs. This includes filing articles of incorporation, holding regular meetings, maintaining corporate records, and adhering to various tax laws and regulations.

 

What is Limited Liability Company (LLC)?

LLC is a business structure that is recognized at the state level.  An LLC can be taxed as a sole proprietorship on your personal return, a partnership, S corporation, C Corporation, or Nonprofit.   The LLC will protect your personal assets from bankruptcy and/or lawsuits.  The LLC will be covered in more detail in each of the different entity types.     Starting your own business is very exciting and liberating.  Choosing your type of business structure shouldn’t be what holds you back.  Your business structure can evolve as your business grows.  When determining which structure best suits you, keep in mind the main differences are taxation, liability, and maintenance.  If you are still having a hard time with your decision, it is always best to consult with a professional. 

Pros: 

1. Limited Liability: Owners’ personal assets are typically protected from the debts and liabilities of the business. This means that if the LLC faces lawsuits or debts, the personal assets of the owners are usually not at risk.
2. Pass-Through Taxation: LLCs are usually taxed as pass-through entities, meaning the profits and losses “pass through” the business to the owners’ personal tax returns. This avoids double taxation experienced by corporations.

 

Cons: 

1. Limited Life Span: Depending on state laws, the lifespan of an LLC might be limited. In many jurisdictions, if a member leaves or dies, the LLC may be dissolved unless there are specific provisions in the operating agreement.
2. Self-Employment Taxes: While LLCs offer pass-through taxation, owners are typically subject to self-employment taxes on their share of the profits, which can be higher than if they were employees of a corporation.