When planning to start a business, selecting your business structure probably the most important decision you have to make. Your business structure affects how many taxes you’ll pay, how you raise the money, the paperwork you file, as well as your personal liability. The most popular small business structure types involve partnership, sole proprietorship, corporation, S corporation, and a limited liability company (LLC). Every type has its own features and benefits, particularly when it comes to taxes. You should select a business structure that offers you the right level of legal protections and reliefs.
Here’s an overview of each small business structure with its tax pros and cons along with how to set up them for your small business.
If a business is owned and operated by several individuals, it’s a Partnership. It can be either a general partnership or a limited partnership. With general partnerships, the partners manage the business and mutually take responsibility for all the debts and obligations. A limited partnership can be general and limited, where general partners manage and take full responsibilities, while limited partners serve as investors and don’t take on any personal liability.
Most businesses opt for Partnership structure because it’s easier to form and the process is inexpensive. A general partnership is more suitable when you expect everyone to be fully liable and take on responsibilities. A limited partnership is not suitable for startups because of detail filings requirements and administrative complications.
Tax treatment among the major benefit of Partnership structure. Your business will not pay taxes on its income, rather it “passes through” any profits or losses to the partners. Along with your business tax filing, each partner also reports his or her share of income and loss at tax time. Every partner handles the taxes personally – making this structure more efficient and preferable for business owners.
- Sole Proprietorship
This is the most simple small business structure, where only one person manages and operates the business. This structure is best suited for individuals that want to retain full ownership of the business and intend to work alone. This is why sole proprietorship is the most popular business structure among business owners.
The business owner is entitled to all the profit and loss of the business. The business expenses you’re your income are included in your personal income tax return. The major benefit of this structure is that it offsets the business losses from income earned from other sources.
The drawback of choosing this structure means you’ll be personally liable for your company’s liabilities and your assets can be put at risk. The taxes in this structure are also paid on a personal level because you and the business are viewed as the same legal entity but at the lowest tax rates as compares to any other small business structures referenced in this article.
Another drawback of this structure is that you might have to face difficulties when raising money for your business. Most traditional lenders might be unwilling to approve you for small business loans. With that said, most sole proprietors count on their savings, home equity or loans from friends and family.
When you don’t want to be personally liable for your business, consider structuring your business as a corporation. However, forming a corporation is complex and costly as compared to other business structures. A corporation is a separate legal entity apart from its owners. The debt and obligations of a corporation aren’t directly tied to the owners – making your personal assets secured. However, it requires compliance with more regulations, accounting, and tax preparation requirements.
It’s a costly business structure where you not only pay corporate income tax for both state and federal but also pay taxes on the personal level for any earnings given to shareholders as dividends.
Another major benefit of forming a corporation is the easiness to raise money for the business. A corporation can easily raise funds by selling its stocks. Moreover, it continues indefinitely, even if any shareholder die, sells the shares or becomes disabled.
- S Corporation
S corporation is more appealing than a regular corporation structure for most business owners. It not only offers tax benefits but also provides the liability protection of a corporation. The profits and losses passed through to your shareholder’s tax returns. Another best thing about using S corporation is that you can add 100 shareholders, allowing you to bring in more working capital.
Forming an S corporation is also complicated with higher legal and tax service costs. After setting up your business, you’ve to file articles of incorporation, hold meetings for directors, shareholders, and keep corporate minutes and allow shareholders to vote on corporate decisions.
The tax process is similar to a sole proprietorship or partnership. When dividends are paid, every shareholder will be taxed, and the remaining income will go towards the business owner. S corporations can only issue one class of stock and owned by individuals, estates and certain types of trusts, unlike in a regular corporation.
- Limited Liability Company (LLC)
Limited Liability Company is another popular small business structure, and incorporate many advantages of corporations and partnerships. The profits and losses will be passed through to your personal tax return and you’ll enjoy the benefit of liability protection as well without the double taxation.
LLCs are similar to S corporations, but there are some key differences. You can add as many shareholders as you want without any limit. Moreover, every LLC member or owner can fully participate in the business – having a stake in decisions.
When setting up an LLC, you need to file articles of organization with the secretary of your state. In addition, LLCs don’t last forever, and some state statutes specify that the company must dissolve after 30 years, or when a member dies, quits or retires.
The Bottom Line
Just like every business type, business structures have their own set of features and benefits. If you need help when deciding on a small business structure, get assistance from a mentor or business experts. When starting a business, you should select a structure that that fits your business!