A Guide to Choosing the Right Business Structure
Starting a business is an exciting endeavor, but with it comes the essential decision of choosing the right business entity.
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Your choice can significantly affect liability, taxation, and day-to-day operations.
At MaxFilings, we’ve created a comprehensive guide comparing six popular business entities, ensuring you’re well-equipped to make the best decision for your venture’s future.
“Entrepreneurship is booming in the U.S. In 2021 alone, a record breaking 5.4 million new business applications were filed.”
Source: https://www.uschamber.com/small-business/state-of-small-business-now
Compare the major business entity types side by side in this handy chart. You can view key differences in entities, including how capital is raised, deductible benefits, income taxes, basic legal formalities, and much more.
Sole proprietorship | General partnership | Limited partnership | C corp | S corp | LLC | |
---|---|---|---|---|---|---|
Business owned by | Sole proprietor | Partners | Partners | Shareholders | Shareholders | Members |
Number of owners | Only one | One minimum | 1 General & 1 limited partner minimum | 1 to unlimited | 1 to 100 | 1 to unlimited |
Owners have personal liability for business obligations | Sole proprietor is liable | All partners are liable | Only general partners are liable | No | No | No |
Management decisions made by | Sole proprietor | General partners | Only the general partners | Board of directors | Board of directors | Members unless the LLC elects manager management |
Effect on business of an owners death or departure | Terminates | Terminates unless partnership agreement states otherwise | Terminates unless partnership agreement states otherwise | None | None | None unless LLC agreement or state says otherwise |
Transfer of ownership | Easy | Consent of all partners usually required by agreement | Consent of all partners usually required by agreement | By stock transfer (securities laws may limit) | By stock transfer (securities laws may limit) | Most LLC agreements require approval of members |
Required paperwork and legal formalities | Minimum | Minimum | Initial filing | Initial filing – record meetings of directors & shareholders | Initial filing – record meetings of directors & shareholders | Initial filing |
Raising capital | From the sole proprietor | From the partners | From the partners | Sale of stock & other permitted instruments | Sale of stock & other permitted instruments | From the members |
Income taxes | Paid by sole proprietor | Paid by partners unless elect corporate tax status | Paid by partners unless elect corporate tax status | Paid by the corporation | Passed thru & paid by the shareholders | Paid by members unless elect corporate tax status |
Who deducts losses | Sole proprietor can deduct from active business income | Active partners can deduct from active business income | Special rules apply – check with tax advisor | Corporation | Passed thru to the shareholders | Special rules apply – check with tax advisor |
Deductible benefits for working owners | Not usually but can deduct medical insurance & set up IRA or Keogh retirement plan | Not usually but can deduct medical insurance & set up IRA or Keogh retirement plan | Not usually but can deduct medical insurance & set up IRA or Keogh retirement plan | Many fringe benefits like stock option & bonus plans – medical & life insurance | Not usually but can deduct medical insurance and set up IRA or Keogh retirement plan | Not usually but can deduct medical insurance & set up IRA or Keogh retirement plan unless elect corporate tax status |
Who finds this entity best for them? | Sole owner who wants no red tape & is OK with personal liability | Multiple owners who want little red tape & are OK with personal liability | Multiple owners with passive owners wanting limited liability & pass thru tax status without forming an LLC | Owners who want limited liability and the ability to reduce overall taxes by splitting income taxes | Owners who want limited liability and pass thru tax status with the formal structure of a corporation | Owners who want limited liability and pass thru tax status |
Helpful business resources
The Best & Worst States to Incorporate In
Where should I incorporate my business? What’s the best state to form my corporation? What’s the worst state to incorporate? Find out the answers here. Learn more
The Best & Worst States for Small Business Lending
Which state offers entrepreneurs the best chances for small business lending? Which states are the worst? It depends on a range of factors… Learn more
MaxFilings tips for aspiring business owners
- Understand your liability: Entities like LLCs and corporations offer limited liability protection, shielding personal assets from business-related lawsuits.
- Consider tax implications: S corps and LLCs can offer pass-through taxation, potentially reducing the tax burden.
- Plan for the future: A C corp might be suitable if you anticipate bringing in investors or going public.
- Seek professional advice: Consult an attorney or CPA when choosing a business structure.
Frequently asked questions: Navigating your business entity choices
How does my choice of business entity affect my personal liability?
Depending on the entity, business owners can be personally liable (as in sole proprietorships) or have limited liability (as in LLCs and corporations).
Are there differences in taxation among these entities?
Yes, for example, C corps face double taxation, while S corps and LLCs typically benefit from pass-through taxation.
Which entity is best for attracting investors?
C corps often appeals more to institutional investors due to their stock structure and familiar governance.
Can I change my business entity later?
Yes, but it requires paperwork, potential tax implications, and possibly legal guidance.
If I want to start a small ‘mom-and-pop’ store, which business formation is best for me?
For a small “mom and pop” store, the appropriate business structure depends on several factors, including their goals, concerns about personal liability, tax considerations, and future expansion plans.
Here’s a general recommendation:
Limited Liability Company (LLC)
Why an LLC might be a good fit for a mom-and-pop:
- Limited liability protection: One of the primary benefits of an LLC is that it provides its owners (members) with limited liability protection. This means that, in most cases, the members’ personal assets (like their homes, cars, and personal bank accounts) are protected from the company’s debts and liabilities.
- Tax flexibility: By default, an LLC offers pass-through taxation, meaning the business isn’t taxed. Instead, profits and losses are reported on the owners’ personal tax returns. This can simplify tax reporting and potentially lead to tax savings, especially when compared to the double taxation faced by C corporations.
- Ease of management: LLCs are known for their flexibility in management. LLCs do not require a board of directors or annual meetings (unless stipulated in the operating agreement). This is conducive to the informal style of a mom-and-pop store.
- Credibility: Operating as an LLC can provide a business with added credibility. Suppliers, customers, and potential lenders or partners often perceive LLCs as more legitimate or established than a sole proprietorship.
Possible drawbacks:
- Cost: Forming and maintaining an LLC might be more expensive than operating as a sole proprietorship. There are often initial registration fees and annual state fees or reports.
- Formalities: While fewer than in corporations, there are still some formalities to observe, like drafting an operating agreement or maintaining separate business bank accounts.
Alternative: Sole proprietorship
If you are looking for the simplest structure, you might consider a sole proprietorship. It’s easy to set up and requires less paperwork than other structures.
However, the major drawback is that the owners are personally liable for business debts or liabilities. This means that the owner’s personal assets are at risk if the business is sued or owes money.
Choosing the right business entity is a pivotal decision that can shape the future of your venture. From understanding liability implications to evaluating tax benefits, every business structure offers its own set of advantages and challenges.
While this guide provides a basic comparison of common business entities, it’s essential to remember that every business’s needs and circumstances are unique.
At MaxFilings, we’re committed to helping you navigate these choices. Whether you’re a budding entrepreneur or an established business owner looking to restructure, let us know how we can help.
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