Business structures are not as complicated as they may seem. When setting out to form your company, you'll want to research each type of business structure. Understanding how each major structure benefits you, as well as burdens you, will ease the anxiety associated with choosing which one is best suited to your needs. In the article below, we discuss the subject of business structures in bite-size pieces so you can digest the information before moving on with further research.
Business Structures Vary By Purpose
Choosing a business structure can fall into a variety of categories regarding purpose. One is protection. Each structure, as described below, provides a different level of protection. The second purpose is to manage taxes as a separate entity, taking advantage of the many write-offs and exemptions available. As a separate entity, you also have the advantage of acquiring health benefits programs not available to individuals.
For tax and growth purposes, an incorporated business can also hire people as employees rather than contractors, developing greater loyalty and longevity in their business practices. Furthermore, the interests held by one partner can easily be transferred to other partners should leaving the business be their decision. This differs from partnerships that must all fully agree on such changes to make them happen. Taking this into account, which business structure should you use?
Choosing Your Business Structure
When you consider a business structure, you should look at exactly what you are trying to accomplish. Is it to simplify taxes or to separate liabilities?
If you choose to not form a legal business entity, you will default to a sole proprietorship. However, this is not recommended. Your taxes may be more of a hassle without the separation of your personal and business accounts. And you won't have the liability protection that an LLC or other business type offers.
Choosing a legal business structure will also help brand your company. It lends to credibility with investors, clients and new hires when you have a legitimate business. This is because most people would rather deal with a serious business owner rather than a single person. However, if you are just a contractor, this could be debatable. Deciding to form a business can make things more complex but can also provide many benefits.
You must weigh your needs when choosing your path. Let's go over the main types of business entities, along with the advantages and disadvantages that come with their formation.
Limited Liability Corporation (LLC)
Limited Liability Companies, or LLC, have grown in popularity during the last 20 years and provide small business owners with protections when it comes to personal assets. LLCs also offer flexibility and do not require a board of directors and the filings that C Corps are responsible for. This means less paperwork and more time and money to devote to building your business.
To receive complete protection of a C Corporation but still operate as an LLC, you can file a corporation status. This means you still are responsible for multiple tax structures, but you don’t have to submit annual reports. A single owner can become an employee of their own LLC under a corporate status and benefit from the efforts made to withhold taxes at the end of the year. It is an attractive option if you are a contractor looking for a more structured way to manage your business. Additional benefits and disadvantages of this entity include:
Personal money or assets will not be required to pay back debts or cover damages when facing a lawsuit.
When it comes to taxes, preparing returns is less complicated for an LLC when compared to a C Corp and can be filed as a pass-through entity.
Being an LLC adds formality and credibility to your business.
Unlike a C Corp, LLCs cannot issue stock, making raising money more difficult.
You must stay on top of all filings and paperwork — this includes hiring a Registered Agent, renewal fees and all other state requirements. Failure to meet state and tax obligations can lead to the dissolution of the business.
Even though an LLC can file as a pass-through, it doesn’t mean that it will pay fewer taxes. LLCs are responsible for Social Security and Medicare taxes.
S Corporations can boast the flexibility of an LLC while allowing transferability of ownership that LLCs cannot enact as a rule. They are less complex than C Corporations because they offer pass-through taxation where taxes are reported on personal income statements. This takes away the double taxation that a company incorporated as a C Corporation incurs. Incfile has an S Corporation tax calculator that will help you see the tax savings over both entities. This will help you decide if incorporating as an S Corporation is the right answer for your new venture.
Much like an LLC, an S Corp provides certain legal protections that help separate and safeguard your personal assets from your business assets.
Owners of an S Corp can also be employees and receive a salary and also receive distributions. This can help reduce your self-employment tax liability.
S Corp ownership can easily transfer to another owner without resulting in the dissolution of the business entity.
Ownership is limited to U.S. citizens and permanent residents. (This differs from C Corps and LLCs, which do not have restrictions and allow foreign nationals to be owners.)
S Corps are limited to 100 shareholders.
Due to the flexibility when it comes to characterizing income as wages or dividends, this type of business entity tends to be scrutinized closely by the IRS, which is on the lookout for business owners who are not fairly accounting for wages on their tax returns.
This type of business entity structure is better suited for larger businesses. It is also a good business structure if you plan to grow your business, become public and offer stock in your business, or you want to attract investors and venture capitalists.
A C Corp has limited liability. This means that creditors cannot attack your personal finances and, often, the company will choose to carry insurance to cover accidents and losses from a variety of situations.
It can exist independently from the owners and will have a board of directors and shareholders.
C Corps have the ability to raise money by issuing stock.
The major downfall of owning a C Corporation is adhering to the strict and often complex tax schedule. Corporations must file monthly, quarterly and annually on state, federal, wage and unemployment insurance taxes.
Filing taxes is more complicated. Having employees complicates tax preparation as you will be required to withhold money from taxes incurred when issuing payments.
There are a number of regulations and formalities involved, including filing annual reports, holding board and shareholder meetings, keeping minutes and creating bylaws.
A nonprofit is a business that has been created for a purpose other than making a profit. Revenue earned by a nonprofit goes toward a specific goal or cause. In addition, money earned by a nonprofit also goes into the business to pay employees, cover overhead costs and even expand. According to the National Center for Charitable Statistics (NCCS), there are more than 1.5 million nonprofits in the United States. Common nonprofit businesses include: hospitals, churches, schools, museums, food banks and homeless shelters.
Nonprofits are exempt from taxes.
They provide legal protection to members so that they are not held personally responsible for a nonprofit’s debts.
Nonprofits work for a greater goal than just making owners and shareholders rich.
Nonprofits need to raise startup funds to start.
They must keep excellent records and make sure to file all paperwork yearly.
Since nonprofits are there to serve the public, they are also under greater public scrutiny.
Legal Business Entities Are Structured to Protect
When you form a business, it becomes its own entity and has a life of its own. In essence, it is like a separate person from you. This means that you, as an individual, are protected from the liabilities that are inherent in running a business. It also becomes independent of shareholders and employees, safeguarding its management, staff and investors. The level of protection differs by structure type, but if you start a legal business entity, you can feel safe in your personal finances. This is different from a sole proprietorship or general partnership where the owner is the business.
For most business owners, an LLC will be the best choice, providing a way for growth, credibility and protection. Incfile can file your LLC for $0 + state fee. Let us handle the paperwork and get you up and running.
Peter Mavrikis is an author and editor with over 25 years of experience in publishing. He has worked as the Editorial Director for Barron’s Educational Series, as well as Kaplan Test Prep, where he ran the test prep, foreign language, and study guide divisions. Peter has also written several books on history, exploration, science, and technology.