What Business Structure is Right for You?

How do you know what type of business entity is best for your organization? Learning the basic design features of each structure and what their advantages and disadvantages are may help you decide. The six structures reviewed in this article are:

• Sole proprietorships
• Partnerships
• Corporations (C Corps)
• S Corps
• Limited Liability Companies (LLC)
• Limited Liability Partnerships (LLP)

Sole Proprietorship

Let's begin with the simplest structure, the sole proprietorship. In a sole proprietorship, the business's assets and the owner's assets are one and the same. The owner of a sole proprietorship is considered self-employed.

• Advantages
  • Least expensive form of business to create
  • More control of your business because you own it and are the lone decision-maker
  • No legal documents to file unless you want to register a DBA or are required to obtain a state business license
  • Sole proprietorships are not taxed
  • Business income and losses reported on a business owner's Form 1040, Schedule C – Profit or Loss From Business, and business losses can offset income from other sources on Form 1040
• Disadvantages
  • Unlimited liability on all business debts and court judgments related to your business
  • Personal finances and business finances intertwined
  • Liability for decisions and actions of employees acting on behalf of your company

Partnership

A partnership is a voluntary contract between two or more people to start a business and proportionally share profits and losses. Owners are not considered employees of the company, but self-employed individuals. A partnership is not a taxable entity.

• Advantages
  • Flexibility allows for ownership by more than one individual
  • Not subject to double taxation
  • Requires few legal formalities
  • Can be started without a written agreement, in which case governed by either the Uniform Partnership Act or the Revised Uniform Partnership Act
• Disadvantages
  • Each partner's personal assets at risk, in addition to all assets of the partnership
  • Unlimited personal liability of each partner for all business debts and court judgments related to the partnership
  • Fringe benefits included as income for all partners
  • All business decisions made jointly
  • Partners extremely dependent upon one another and legally entwined in each other's business and liabilities

Corporation (C Corp)

A corporation is a legal entity that exists separately from its owners. Owners are not self-employed, and shareholders own the equity in the corporation.

• Advantages
  • Limited liability for shareholders
  • Ownership easily transferable
  • Potential for increased business efficiency through centralized management
  • Easier to access additional capital through the sale of stock
  • Qualified retirement plans more easily set up
  • May offer a greater variety of qualified fringe benefits than any other type of entity
• Disadvantages
  • Complex and expensive to establish and maintain
  • Possible additional taxes that do not apply to partnerships and S Corps
  • Tax losses not deductible on an individual tax return
  • More extensive recordkeeping requirements
  • May be subject to double taxation (Tax is paid on profits at the corporate level and again by shareholders on dividends.)
  • Requirement to pay unemployment insurance taxes on employees' wages

S Corp

An S Corp is a standard business corporation that has elected a special tax status. The S Corp can have no more than 100 shareholders, and shareholders are taxed like a partnership and have limited liability. Profits and losses pass directly through to the shareholders, and income is not taxed at the corporate level.

• Advantages
  • Single taxation
  • Income taxed only at the shareholder level
  • Shareholders not considered self-employed (except for benefit purposes)
  • Deductibility of losses passed to shareholders (subject to possible limitations)
  • Shareholders, like partners in a partnership, not generally subject to FICA tax on medical and health expenses paid by the S Corp
  • Deductibility of interest expense for shareholders who have incurred debt to acquire the stock of the company if they materially participate in the company
• Disadvantages
  • Limited opportunity to shift income because of calendar year accounting
  • Requirement that all shareholders be individuals (e.g., no corporations, partnerships, etc.) and U.S. residents (citizens or resident aliens)

Limited Liability Company (LLC)

A Limited Liability Company (LLC) is a contractual arrangement among the owners (members) affording limited liability (similar to a C Corp). Owners have the choice of the LLC being taxed like a partnership or a corporation, and would then be taxed as partners or shareholders, respectively, although LLCs are generally treated as partnerships for federal tax purposes. Shareholders/members have limited liability.

• Advantages
  • Liability of the owners (or members) limited to their investment
  • Owners typically not personally responsible for the debts and liabilities of the business
  • Protection from liability for claims involving the wrongful acts of another member when there is no knowledge of those acts
  • Unlimited number of owners
  • Freedom to establish ownership and management relationships
• Disadvantages
  • Varying organizational and operational requirements from state to state
  • Possibility that state tax treatment may not follow federal tax treatment
  • At least two owners required in some states
  • Dissolution required by most states upon death, retirement, expulsion bankruptcy, or dissolutions of any member (At that time, all remaining members consent to reinstate the LLC.)
  • LLC stock transfers subject to approval by all owners

Limited Liability Partnership (LLP)

A Limited Liability partnership (LLP) is another common entity. It works basically the same as an LLC, except that an LLP must be taxed as a partnership. An LLP does not have the choice of being taxed as a C Corp.