Are you an existing business thinking about making a structural change, or an entrepreneur looking to start a new business but unsure which structure you should go with? This article will help you understand the best business structure for your company’s needs. Is an LLC the best way to go, or maybe a corporation? We’ll put your mind at ease and help you understand what’s available.
Out of all the structures to choose from, a sole proprietorship is the simplest, yet one that very few business owners should consider — and for good reason: They give you no legal protection. I’d like to tell you that business is easy and there’s nobody looking to take advantage of you…but unfortunately, reality can be more disturbing.
With a sole proprietorship, you are in control of your entire business alone — just you. However, you are also getting zero protection for your personal assets from this structure. What does this mean? Let’s say your business were sued for any reason. The accuser would be able to go after the money in your personal bank account, your house, your car, your soap, even the buttons on your shirt…EVERYTHING. You as an individual are responsible for 100% of your business liabilities. For that reason, I highly recommend you do not utilize a sole proprietorship as your business structure.
With a sole proprietorship, you file a Schedule C and Schedule SE with your personal 1040 tax form, which shows the amount of tax you owe from your business. You must also pay quarterly taxes under this structure.
Limited Liability Companies (LLC)
A very popular structure is the Limited Liability Company, or LLC. An LLC structure is similar to the sole proprietorship in that it is considered a “pass-through entity,” under which all profits and losses need to be filed on the individual’s tax return.
However, unlike the sole proprietorship, the LLC structure provides separation between your business and personal assets. So, unlike in the example above, your accuser wouldn’t be able to go after your personal assets — unless you had a pattern of “piercing the veil” of your business by not properly operating your business according to the LLC structure and requirements.
An LLC could be the best business structure for your needs if you are an entrepreneur looking to run your own business without a partner. If you do want to bring on “shareholders” to your LLC, you may have as many as you wish — they’ll simply be listed as “owners” alongside you. You are also in complete control of your business and its day-to-day operations. The tax structure is identical to that of a sole proprietorship, where you file a Schedule C and Schedule SE with your personal 1040 tax form.
If you and another individual decide to start a business together, it could be formed as a partnership. In a general partnership, both partners have responsibility for the business operations, as well as any debts and obligations. In a limited partnership, one or more individuals usually serve as the general partners and maintain the responsibility, while the limited partners serve as investors who have no control over the company or its daily operations. Limited partners in this structure would not assume any responsibility for liabilities or debt.
Limited partnerships can become extremely paperwork intensive, and for that reason many entrepreneurs do not choose this route for forming their business. It would be much easier to form a general partnership, where all owners of the business are actively working on the business and its growth. However, one downside of a general partnership is that it is similar to a sole proprietorship — each partner is fully liable for any debt or judgments against the company. The general partnership offers no protection for personal assets. Additionally, if one partner decides to make a drastic change to the business, such as taking out a large loan, the other partner is on the hook for that loan as well. For that reason, it is wise to only partner with someone you can trust.
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.
S Corporations are similar to an LLC in that they are considered a “pass-through entity.” The business itself is not taxed, but the owner is. Additionally, an S Corporation provides liability protection for the owner’s assets. S Corporations can have up to 100 shareholders if they wish, but are only able to issue one class of stock — which could limit their ability to raise capital.
One downside to an S Corporation is that you must designate directors, and all major decisions of the corporation must be voted on by the shareholders. While S Corporations have some similarities to an LLC, choosing this entity means you remove the owner’s ability to make decisions on his or her own.
In terms of taxes, S Corporations file profits and losses on the owner’s individual 1040.
Unlike the other structures mentioned above, C Corporations get hit with double taxation and are less common in the small business realm. You will generally find C Corporations used by large companies, since they are a fairly compelx structure that involves more regulations and tax requirements. However, like an S Corporation, the C Corporation also provides owners a way to limit their liability so their personal assets are protected.
When using a C Corporation structure, the business can raise capital through both common and preferred stocks. Since operating a C Corporation is much more expensive than the other structures, that money goes to good use keeping the business running.
Those who use a C Corporation structure would be wise to hire an accountant as well as an attorney to navigate all the legalities involved. Taxes can be quite complex within this structure, since C Corporations are subject to federal and state taxes on the company, and shareholders will be taxed again on any profits via their personal income taxes.
If you have any questions regarding the different structures and which one is best for your business, Incfile has some great resources to help educate you further. Additionally, if you need help managing your business once you get up and running, the highly skilled staff at Incfile offer many services to help keep your business in good standing.