Strong buildings, whether they're a modest family home or a towering skyscraper, have one key element in common: they are built on a solid foundation. By starting with the right structure, they can grow, evolve and stand the test of time. The same is true for businesses. If you’re in the planning stages of launching your business, laying the right foundation is integral to your future success. But how do you know which business structure is right for you? We’ve got the insight that will help you make one of the most fundamental, and most impactful, decisions that will set the course for your new business.
Types of Business Structures
You’ve likely heard of many of the various business entities available to entrepreneurs. But what do they all mean? Each type of business structure comes with its own unique benefits…and its own pitfalls. Deciding on a structure is a highly personal process, and depends greatly on the goals and vision you have for your business. Read on to learn more about the business entities Incfile can help you form, and when you’re ready, take our Business Entity Quiz to confirm which one best suits your needs.
Limited Liability Company (LLC)
While it’s not a one-size-fits-all approach to doing business, there’s a reason LLCs are the most popular business entity for Incfile customers and businesses worldwide. In fact, more than 80 percent of small business owners choose an LLC when forming their company. LLCs offer a hybrid structure that allows owners more control of their business while protecting their personal assets in the case of financial or legal hardship.
LLCs are flexible entities, managed by individual or multiple owners.
They are considered a “pass-through entity,” which means all profits and losses are filed on the owner’s personal tax return, without facing corporate taxes. You’ll need to file a Schedule C and Schedule SE with your personal 1040 tax form.
An LLC creates separation between your business and personal assets so that your car, home and personal savings will be protected should you face bankruptcy or lawsuits.
LLCs are not indefinite entities. They are filed by state, and each state has different regulations for changes to the business. You may need to dissolve the business and reform if you move to another state, if another owner leaves the business or if a new owner is added.
Compared to other structures, LLCs can require more legwork on the part of the business owner, with forms and state filings. Fortunately, that’s why Incfile exists: to make the formation process seamless, simple and hassle-free.
S Corps are similar to both C Corps and sole proprietorships in different ways. They offer the protection of a corporation while avoiding the double taxation challenge that faces C Corps. S Corps are better choices for small businesses that want ownership flexibility and tax benefits while lowering personal risk.
Like LLCs and sole proprietorships, S Corps are considered “pass-through entities,” reducing tax liability for shareholders.
Because of their pass-through setup, S Corps are not subject to the same double taxation as C Corps.
Like a C Corp, S Corps operate as a separate entity from owners, so when a shareholder leaves or passes away, the business continues relatively undisturbed.
S Corps have more restrictions than C Corps and must have fewer than 100 shareholders.
They must also be considered domestic businesses, with all shareholders required to be U.S. citizens or legal residents.
S Corps are restricted to only one class of stock, meaning they may have more problems raising capital.
A C Corp is most often found in larger businesses. By forming a C Corp, you create an entity that is entirely separate from its owners. It can generate a profit, it's taxed apart from its owners and shareholders and it's legally liable in its own right.
Owners and shareholders are protected in a C Corp, as their assets are never at risk in the case of financial or legal difficulty.
C Corps can sell stock, which can help when cashflow is needed. It can also be an attractive benefit to potential employees.
C Corps remain mostly unchanged in the event of a shareholder or owner leaving the company.
C Corps are generally more expensive to form than other business entities.
Because of their structure, C Corps are held to more exacting regulations and requirements, with regular filing and reporting required.
C Corps often face double taxes, paying first on their profits, and then again when dividends are paid out to shareholders.
If your business goal is more focused on impact than on profit, this might be the right structure for you. Nonprofits direct revenue to causes or organizations, rather than to shareholders. They are not owned by an individual or group, and though they can be sold, any assets must be used toward the benefit of the organization.
Nonprofits, when filed and approved as a 501(c)(3), are considered tax-exempt, meaning all donations to the organization by individuals are tax deductible.
As in LLCs and corporations, nonprofit founders are typically protected from legal liability.
Nonprofits that go through the formation process are more likely to set stronger missions that help them achieve their goals.
Government requirements for filing as a 501(c)(3) are stringent, and the filing of incorporation is only the first step in becoming a recognized nonprofit organization.
Reporting requirements for nonprofits are much tougher than those of other business structures, and due to the nature of the organization, are generally under more scrutiny.
Compared to other types of entities, nonprofits can be more costly and time-consuming to launch.
If you’re forming a business on your own, you might think a sole proprietorship is a no-brainer. This structure is the simplest to set up, mainly because there really isn’t any setup. To run a sole proprietorship, you simply need to operate your business. There is no sole proprietorship filing or registration, though if you’re doing business under any name other than your own, you may need to file a Doing Business As (DBA). In short, with sole proprietorships, there's a lack of legal protection.
The easiest and quickest business structure, sole proprietorships give owners total control over every aspect of the business.
Taxes are considered “pass-through,” like LLCs, and can be filed with the Schedule C and Schedule SE on your 1040 tax form.
Sole proprietorships can be good options for low-risk business owners who want to test their idea before an official launch or business formation.
Sole proprietors have zero protection against risk and liability. In the event of financial struggle or legal problems, the owner’s personal assets are on the line.
It can be difficult to secure funding for sole proprietorships due to the increased risk, lack of business partners and inability to sell stock in the company.
If you’re forming a business with someone else, you may be interested in a partnership structure. Partnerships come in various forms that will impact the way you do business and the way you share responsibility with your partner(s). General partnerships are very similar to sole proprietorships, in which all parties assume equal responsibility and liability for the business. Limited partnerships assign a general partner who assumes primary responsibility, while the limited partners are protected from liability.
In a general partnership, you share both the risk and the reward of operating your business with an individual or team that has just as much at stake as you do in making the company a success.
If you are the general partner of a limited partnership, you have the most control over the operations of the business.
For tax purposes, partnerships are still considered “pass-through,” and each partner must file a Form 1065 with their personal taxes. Additionally, each partner also reports their own share of income and loss on a Schedule K-1.
General partnerships offer no protection of personal assets, so while you have equal partners to share the workload and responsibility, you are also equally at risk of financial or legal troubles.
In a limited partnership, while partners are off the hook when it comes to risk and liability, they also have no legal control over the company or its daily operations.
Limited partnerships are heavy on the paperwork, which deters some entrepreneurs from forming them.
Ultimately, the right business structure depends on what you want out of your new venture. You’ll need to consider if you want to be the sole decision-maker or if you want the support of trusted partners. You must also look at the tax implications of each type of entity and determine which will meet your current needs. Finally, and most importantly, ask yourself which business type will offer you the greatest financial and legal protection, should you need it.
If you still aren’t sure, take our Business Entity Quiz and allow us to guide you through your decision-making process. Remember that by laying a strong foundation now, your business will have the strength and support it needs to withstand any storm.
Wendi is a freelance writer based in Indianapolis, IN, with over a decade of experience writing for a variety of industries from healthcare to manufacturing to nonprofit. When she isn't working on solutions for her clients, she can be found spending time with her kids and husband, working in the garden or doing more writing (of the fiction variety).