As you prepare to start your business, you will need to choose a business structure. A business structure refers to an organization's legal structure (your company in this case) that is recognized in a given jurisdiction. The business structure you chose will impact how your business operations function in the day-to-day, which tax rates and forms apply, and your personal liability. There are several different types of business structures:
A sole proprietorship is an unincorporated business. This means the company does not need to be registered with the state to operate and is owned entirely by one person. Sole proprietorships are one of the most popular forms of business ownership and the easiest to set up. While the simplicity of operating a sole proprietorship appeals to many business owners, it is essential to understand the personal legal and financial risks that can be associated with a sole proprietorship business. In a sole proprietorship, the business owner can be personally responsible for debts and obligations, and there is no legal separation between you personally and the business. This means that your personal assets could be seized if the business fails and incurs debt. An additional consideration is it can be challenging for sole proprietorships to raise money and secure business loans because you can’t sell stock, and there is no differentiation between personal and business assets.
A partnership is a business that multiple owners share. In a partnership, all partners contribute to the company and share in the profits and losses of the business. There are four different types of partnership businesses:
- General Partnership
A general partnership is the most common, simplest, and least expensive type of partnership to establish. Like a sole proprietorship, a general partnership is an unincorporated business. In a general partnership, the partners have unlimited personal liability; therefore, the company's debts and liabilities are not capped, and the partners can be personally liable through their personal assets. While not required, it is recommended that the general partners establish a partnership agreement which details how the business is run and the relationship between the partners.
- Limited Partnership
A limited partnership is a partnership with two or more partners and one general partner. The general partner has unlimited liability for business debt, whereas the partners have limited liability determined by their investment in the business and terms of the partnership agreement.
- Limited liability partnership
A limited liability partnership provides limited liability to every partner. While the partners are still liable for business debts and liabilities, they are not responsible for the errors of their partners. Limited liability partnerships are typically seen in the businesses of lawyers, accountants, or doctors.
- Limited liability limited partnership (LLLP)
A limited liability limited partnership is the newest type of partnership and is not authorized in every state. Be sure to check if your state recognizes LLLPs. Like a limited partnership, there are general partners and limited partners. However, the LLLP limits the general partners and limited partners liability.
Limited Liability Company (LLC)
A limited liability company, also referred to as an LLC, is a popular business structure among small business owners. An LLC protects owners from personal liability for the company’s debts and liabilities while still providing operational flexibility. In general, LLCs are the simplest business entity to form and operate and do not require many administrative requirements such as shareholder meetings, like a C Corp or an S Corp do.
LLCs provide owners with pass-through taxation, meaning that the profits and losses pass through the business to owners, and the LLC pays taxes through their individual tax returns. Unlike corporations, which are all taxed at a flat rate, LLC tax rates vary based on the individual tax code rates.
To form an LLC, owners, also referred to as members, complete an operating agreement, file articles of organization with the state, and obtain a certificate from the state.
C Corporation (C Corp)
A C Corporation or C Corp is a corporation business structure. Shareholders own C Corps, and there is no limit to the number of shareholders that a C Corp can have.
In a C Corp, the owners’ and shareholders’ assets and income are separate from the corporation providing owners and shareholders with limited personal liability. The C Corp pays tax on the revenue at a corporate level, and shareholders’ dividends are also taxed. The taxation on the business revenue and the shareholders’ dividends is typically referred to as double taxation.
S Corporation (S Subchapter or S Corp)
An S Corporation, also known as an S Subchapter, gets its name from Subchapter S of the Internal Revenue Code which details how they are taxed. Businesses must meet certain requirements to qualify for the S Corp status.
S Corps can pass corporate income, losses, deductions, and credits to their shareholders and are taxed like a partnership. This allows S Corps to avoid the double taxations that are subjected to C corps.