Choosing the appropriate legal structure for your business is one of the most important aspects to starting a new business. In many cases, this decision is made without much thought or is even overlooked.
There are many different business structures, each one with its own pros and cons. Different structures reflect different goals and objectives. They also determine the legal status of the business, establish ownership, and establish the way in which the business will be taxed.
Understanding these structures, and choosing the best one for you, is a crucial first step in starting a business. Below, is an outline of some of the most common forms.
Limited Liability Company (LLC)
A Limited Liability Company is a business structure that combines pass-through taxation of a partnership with the limited liability of a corporation. That means profits and losses pass through to the owners. LLC’s offer protection from personal liability for business debts, and owners typically risk losing only on what they have invested in the LLC. For this reason, this entity is often considered a “best of both worlds” approach.
C-Corporation
This type of structure, under United States federal income tax law, refers to a corporate entity that is taxed separately from its owners. With this type of structure, income is first taxed at the corporate level, and then taxed again when it’s distributed to the owners. The double taxation can be seen as a drawback initially; however, the advantage is that profits can be reinvested in the company at a lower corporate tax rate. C-corporations also have no restrictions on ownership offering additional flexibility.
S-Corporation
A structure that designates a corporation as a unique entity, separate and apart from those who own it. This type of entity limits the financial liability of the owner or shareholder. Like an LLC, S-Corp profits and losses pass through to the shareholders, as the business itself is not taxed. If there is more than one owner, however, you must file an informational tax return to report each shareholder’s portion of the corporate income.
Partnership
A partnership structure consists of a single business where ownership is shared between two or more people. Partners often contribute all aspects of the business and share in the profits and losses. They are also liable for all business debts and obligations. Like LLC’s and S-Corps, income of Partnerships passes through to the partners where it is taxed. Though a formal partnership agreement is not legally required, it is very risky to operate without one.
Sole Proprietorship
This is the simplest business form and arguably the most popular among small businesses. Unlike some of the other forms listed above, the sole proprietor does not establish a legal entity. This structure refers to a person who owns the business and is personally responsible for its debts. While the simplicity is alluring, the biggest disadvantage is that the owner is personally liable for all debts. Taxation for sole proprietorships is very direct and simple. The income earned by the business is income earned by the owner, who is taxed accordingly.
For a more in-depth look into which structure best fits your needs, you should seek the advice of a CPA and attorney. Stanko, Senter & Mitchell specializes in helping entrepreneurs navigate the process of starting a new business. We would be pleased to assist you in the process. Contact us today!
