Every business needs a business structure. The structure you choose for your business influences your operations, taxes, and the number of personal assets that are at risk.
Different Business Entities
You need to make sure that you are choosing a business structure that gives you legal protections and benefits. Choosing the right structure involves understanding the differences of each entity.
Consulting with business counselors, business lawyers, and accountants is also a good idea to ensure that you choose the right business structure for your company.
Here are the different business entities:
As the name suggests, sole proprietorship means that you are the sole owner of the business. You have complete control of the company.
Although “complete control” sounds good, keep in mind that sole proprietorship does not produce a separate business entity. All your business assets and liabilities are not separate from personal assets and liabilities.
Since you are the sole owner of the company, you can be held personally responsible for any debts and obligations that the business incurs.
You will have a trading name, but you cannot sell stocks. This business structure is a suitable choice for entrepreneurs looking to test ideas before starting a more formal business.
This type of entity is the simplest structure for businesses with two or more owners.
There are two kinds of partnerships:
Limited Partnerships (LP)
Limited partnerships have only one general partner with unlimited liability, and all other partners have limited liability. The partners with limited liability also tend to have limited control over the company, which is documented in a partnership agreement. Profits are passed through to personal tax returns, and the general partner — the partner without limited liability — must also pay self-employment taxes.
Limited Liability Partnerships (LLP)
Limited liability partnerships are similar to limited partnerships, but give limited liability to every owner. An LLP protects each partner from debts against the partnership, they won’t be responsible for the actions of other partners.
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 liability company (LLC)
LLC is the type of business entity that protects you from personal liability. Personal assets will not be at risk in case your LLC experiences bankruptcy or lawsuits.
You can transfer any profits or losses through personal income without corporate taxes. However, LLC owners are considered self-employed, which means that every member should pay self-employment tax contributions.
Although it has its benefits, LLCs can be quite limited in many states in the US. Some states require LLCs to dissolve and THEN re-form whenever a member joins or leaves, except when there is an agreement within the LLC about buying, selling, and transferring ownership.
LLCs are suitable for business owners with significant personal assets they want to be protected. This business structure is also a good choice for proprietors who need to pay a lower tax rate than they would with a corporation.
There are different kinds of a corporation:
A C-corporation is a legal entity separate from the business owners. This type of entity can make a profit, be taxed, and can be held legally liable.
Among all the business structures, corporations offer the strongest protection to members from personal liability. However, it is the most expensive structure to form.
Corporations need more extensive record-keeping especially because they pay income tax on their profits.
There are cases in which corporate profits are taxed twice. First when the business makes a profit, and again when the company distributes the dividends to each shareholder– but this time in the form of personal tax.
An S corporation is a special type of corporation designed to avoid double taxation.
A benefit corporation is different from C corps in purpose, accountability, and transparency. B corporations are motivated by both mission and profit.
In addition to financial gains, shareholders hold the corporation responsible for producing some form of public gain. Some states mandate that the B corps send annual benefit reports demonstrating their contribution to the public good.
Close corporations are similar to B corps, but with a less conventional organizational structure. These remove numerous formalities that usually regulate businesses and apply to smaller firms.
The laws of the state vary, but securities are generally barred from selling publicly. A small group of shareholders without a board of directors may operate closed companies.
Nonprofit corporations are formed to do charity work that may be related to education, social, literary, or science work. Non-profits may earn tax-exempt status since their work benefits the public— meaning companies under this structure do not need to pay federal or state income taxes for any revenue they generate.
To get a tax exemption, charities must comply with the IRS, a separate method from registering with their state.
The type of business entity you choose plays a very significant role in your company’s operations. It affects the roles, paperwork, and many other important details that you need to work on and prepare for the company.
The business structure you choose can also influence how people recognize your company, and it has a massive impact on your legal exposure and finances. You can always consult with an accountant or a business lawyer if you are unsure of anything.