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Benefits and Drawbacks of Different Types of Business Entities

Future business owners need to consider the different types of business structures when they set up their new business. Each type has its own special rules about things like management, personal liability, and taxes. The type of business structure you choose will depend on several factors, including the nature of the workforce within your organization, the goal of the company, and so on. 

Each legal structure for business entities has its advantages and disadvantages, so it's best to eliminate the ones that simply wouldn't fit with your organization before choosing. Let's look at the different types of business structures entrepreneurs should consider.

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Benefits and Drawbacks of Business Entity Types

When you're starting up your business, you have many different options. Each one comes with its own pros and cons. Some of the main benefits and drawbacks of different types of business entities or legal structures are listed below:

 

Main Advantages Main Disadvantages
Sole Proprietorship
  • Easy to create and maintain
  • The business and owner (the sole proprietor) are legally the same entity
  • The owner has complete control
  • No fees associated with the creation of the business entity
  • The owner may deduct a net business loss from personal income taxes
  • The owner is personally liable for any debts, judgments, or other liabilities of the business (unlimited liability)
  • Owner must pay personal income taxes for all net business profits and self-employment taxes for Medicare and Social Security
  • It is tougher for these owners to secure a business loan
General Partnership
  • Easy to create and maintain
  • No fees are associated with the creation of the business entity
  • The owners may report their share of net business losses on personal income taxes (pass-through taxation)
  • All owners are jointly and personally liable for any debts, judgments, or other liabilities of the business
  • The owners must pay personal income taxes for all net business profits
Limited Partnership
  • It is easy to attract investors as they are only liable for the total amount of their investment into the business
  • The limited partners enjoy limited liability protection for any debts, judgments, or other liabilities of the business
  • The general partners are more free to focus their attention on the business
  • General partners are able to raise cash without diminishing their control of the business
  • Limited partners can leave the business without dissolving the limited partnership
  • General partners are jointly and personally liable for any debts, judgments, or other liabilities of the business
  • Limited partnerships may require a filing fee
  • Can be more expensive and complex to create than a general partnership
  • Mainly suited to businesses such as real estate investment groups or in the film industry
Regular Corporation (C Corporation or C Corps)
  • The owners of the business enjoy limited liability for the business's debts, judgments, and other liabilities, meaning their personal assets are shielded
  • Some benefits may be deducted as business expenses
  • With good accounting, owners and businesses may be able to pay lower taxes by splitting the business profits among owners
  • More expensive to establish than a sole proprietorship or partnership
  • Complicated paperwork that must be filed with the secretary of state
  • The corporation must pay its own corporate taxes as a separate legal entity
  • The owners of the corporation face double taxation
S Corporation
  • Owners of the business enjoy limited liability for the business's debts, judgments, and other liabilities
  • Owners share the net profits of the business and report their share on personal income taxes
  • Owners share the net business loss and can offset other income by reporting this loss on personal income taxes
  • More expensive to establish than a sole proprietorship or partnership
  • Paperwork is more complicated than the paperwork required for an LLC, but similar advantages
  • The ownership interest of the various owners determines their respective incomes from the profits of the business
  • Some benefits are only given to owners that have more than 2% of the business' shares
  • These corporations are subjected to higher Internal Revenue Service (IRS) scrutiny
Professional Corporation
  • Owners are not personally liable for the malpractice of other owners
  • More expensive to establish than a sole proprietorship or partnership
  • The paperwork and filings may be onerous to owners
  • In this corporate structure, the owner must be in the same profession as all other owners
Nonprofit Corporation
  • The corporation does not pay income taxes on money it receives for a charitable purpose
  • Donors who give for a charitable purpose may deduct their donations from income taxes
  • Some benefits may be deducted as business expenses
  • The full tax benefits and advantages can only be utilized by businesses that have been incorporated for a charitable, educational, scientific, religious, or literary purpose
  • If the property is transferred to the nonprofit corporation, the property must stay with the corporation. Even if the corporation ends, the property must go to another nonprofit
Limited Liability Company (LLC)
  • The owners of the business enjoy limited liability for the business's debts, judgments, and other liabilities, even if the owners engage in significant control of the business
  • The business profits and losses can be allocated to the owners along different lines than ownership interest (for example, a 10% owner may be allocated 30% of the business' profits)
  • The owners can choose how the LLC will be taxed, either as a partnership or a corporation, on corporate income
  • More expensive to establish than a sole proprietorship or partnership

Professional Limited Liability Company

  • Allows state-licensed professionals to enjoy the same advantages as an LLC
  • The same disadvantages as an LLC
  • All members must belong to the same profession
Limited Liability Partnership
  • Business entities associated with things like law, medicine, and accounting normally use this
  • Partners are not liable for the malpractice of other partners
  • Partners take their share of loss or gain on their personal income taxes
  • Partners remain personally liable for obligations to business creditors, landlords, and lenders
  • Not every state allows limited liability partnerships
  • Often limited to only a select few professions

Choosing the Right Business Structure

When you're about to begin a startup, picking the correct entity for your business is critical. It affects your level of personal liability, tax obligations, and your ability to raise money. Think about whether you're comfortable with your personal assets being at risk if your business is sued. Consider how different tax implications, like self-employment taxes or corporate taxes, will impact you. Some structures allow you to bring in co-owners easily, while others give you more personal control.

Each type of entity demands different paperwork, like tax returns for a sole proprietorship or articles of incorporation for a C corp. Understand what each structure entails in terms of filing fees, federal income tax, and responsibilities like drafting an operating agreement or bylaws. It's a decision that influences not only the day-to-day operations but also the long-term growth and sustainability of your business. 

Consulting with a legal expert can provide clarity on the nuances of each option. They can help you make an informed decision that aligns with your business goals and personal needs.

Get Help You With Your Business Structure Today

The operation of your company will be formed largely by the type of business entity you choose, which will depend on a number of factors. There's no one-size-fits-all approach to making this decision. We can help you walk through the decision-making process through our DIY business formation services.

business organization attorney can also help you determine what's best for your small business.

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