If you want to start a company, you have many types of business structures from which to choose. The business structure you select can impact how much you pay in taxes, how much paperwork you file, your personal liability, and even your ability to raise money. If you’re starting a company, it might be helpful to learn more about these structures and how they function.
In this article, we discuss seven different types of business structures and offer tips to help you choose the right one for your company.
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7 types of business structures
While liability, ownership rules, taxes, and filing requirements can vary by state, these are the most common types of business structures and their requirements:
1. Sole proprietorship
This is typically the simplest type of business, with only a single person or a married couple responsible for all the company’s profits and debts. If you intend to work alone, this may be the best option for you. This type of business can be especially appealing because income and expenses appear on your personal income tax record.
Your profits and losses appear on the Schedule C tax form and the amount transfers to your personal tax return. Losses you suffer in the business can offset income earned from other sources. With this type of business, you also have complete ownership and make all the decisions.
The disadvantage of a sole proprietorship is that you’re personally liable for your company’s debts. This means that your personal assets may be at risk if you have to satisfy a business debt or settle a legal claim filed against you.
2. Partnership
A partnership can be an ideal choice if your business is going to be owned and operated by multiple people. This type of business comes in two forms: general partnerships and limited partnerships.
With a general partnership, the partners assume responsibility for the debts. In a limited partnership, there are both general and limited partners. Limited partners are investors only, have no control over the company and aren’t subject to liabilities, while general partners own and operate the business and assume liabilities.
Unless you intend to have multiple passive investors, the limited partnership may not be the best model. This is because of the administrative complexities and extensive filings required. If you expect to have two or more partners who are actively involved in the business, a general partnership is often simpler.
A partnership doesn’t pay tax on its income but instead passes the profits and losses on to the partners. However, they’re typically more expensive to start because of the extensive accounting and legal services required.
3. Limited liability company (LLC)
This type of company allows owners, partners and shareholders to limit their personal liability in order to protect their personal assets. An LLC is not incorporated but it enjoys the limited liability of a corporation. The LLC may be a sole proprietorship, partnership, or corporation for tax purposes.
One of the benefits of an LLC is that there aren’t any limitations on the number of shareholders the business can have. Also, any owner or member can have a full participatory role in the operation of the business. There’s also flexibility concerning the distribution of profits.
LLCs don’t have to distribute profits and losses in proportion to the money that the investor puts in. The disadvantage of this type of business is that because LLCs are a relatively new business structure, the tax treatment can vary by state.
4. Corporation – C corp
Corporations offer the strongest amount of personal liability protection, but the cost to form a corporation is also higher. Corporations also require extensive reporting, record-keeping and complex operational processes.
They’re also completely independent of shareholders. They pay income tax on profits and, in some cases, can experience double taxation. They have an advantage when raising capital because they can raise money by selling stock.
5. Corporation – S corp
An S corporation has the liability protection of corporations along with additional tax benefits. The owners of S corporations can use the cash method of accounting if they don’t have inventory. They can also have up to 75 shareholders, which makes it possible to attract more capital.
S corporations must file articles of incorporation like all corporations and hold director and shareholder meetings. They also must allow shareholders to vote on major decisions. S corporations can only issue common stock, which could impact the corporation’s ability to raise capital.
6. Corporation – B corp
A B corporation, also called a benefit corporation, is a for-profit corporation that’s led by mission and profit. They’re in the same tax category as C corporations but remain focused more on purpose, accountability, and transparency. In order to qualify as a B Corp, a company must receive a certification that recognizes its dedication to social and environmental responsibility and transparency.
7. Corporation – nonprofit
Nonprofit corporations focus on philanthropic work. Because their work benefits the public, they can receive tax-exempt status and not pay taxes on profits. They follow organizational rules similar to those of a C corp but also have special rules regarding profits.
Factors to consider when choosing the right business structure
Here are the main factors to consider before choosing a legal structure for your business:
Flexibility
Your goal when selecting a type of business is to identify the one that allows for maximum flexibility given the ownership structure. Try to consider the goals, concerns, needs, and financial situations of each owner. This can help your company grow and adapt to changing circumstances as it matures.
Liability
Another factor you can consider when forming your business is the type of liability protection you need. Try to examine the risks your company might encounter and decide if you can assume the liability personally. If you can’t, a partnership or sole proprietorship is likely not the best type of business to start.
Complexity
It’s important to establish the level of complexity you want to take on when starting your business. Sole proprietorships are the simplest option, and incorporating your business can become highly complex, with state and federal reporting requirements. Unless you have extensive business expertise or plan to work alongside a team, try to choose the simplest viable structure for your company.
Taxes
When you start your company, consider its future tax requirements. Make sure to research your state’s laws and find out how you can reduce the business’s tax burden. If you’re looking for greater flexibility, there are more tax options for corporations than for partnerships or sole proprietorships. However, double taxation can be a problem with corporations which you can afford by starting an S corp.
Control
It’s important to determine the amount of control you want over the business. If you want to have complete control, an LLC or sole proprietorship may be the best choice. If you choose to incorporate, you may be able to control your company while it’s young. However, as businesses grow, they usually come under the control of a corporate board.
Capital investment
If you plan to seek outside funding for your business, you may want to establish a corporation. Corporations can secure additional funding and sell stock as opposed to sole proprietorships, which can only obtain funding through their personal bank accounts or by taking on partners. Whatever model you choose, make sure that it has the flexibility to accommodate growth as the company expands.
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