Types of Business Structures
One of the most important decisions entrepreneurs face is choosing their corporate structure. This is an important decision for new business owners. The business structure impacts your business's tax status. This, in turn, affects how you file your income tax return and what paperwork to file for your business. It also impacts how your business raises money.
The IRS recognizes several different types of business entities. Each business structure has its pros and cons. Since every business is unique and has its own needs and goals, do your research before choosing. The following is an overview of the various types of business structures. Let's explore the most common types and their implications for business owners.
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A sole proprietorship is a simple business structure. In this structure, an individual owns and operates the business. There is no legal distinction between the owner and the business entity. Unlike other types of business structures, there are no papers to file or fees to pay to create it. You are the sole owner of your business. You simply need to begin business operations to create a sole proprietorship.
In a sole proprietorship, you will pay taxes on any business profit as income on your personal taxes. If your business has any liabilities, such as a court judgment or a past-due debt, you are personally liable for them. In other words, you are responsible for paying them. You might face self-employment taxes on your business income.
You should consider opening a separate bank account for your business expenses, even if you are a sole proprietor. Opening a bank account as a sole proprietor is straightforward. For more information, visit FindLaw's Starting a Sole Proprietorship FAQ page.
When two or more entrepreneurs come together to run a business, they often form a partnership. A partnership is like a sole proprietorship in many ways. Likewise, the owners of a partnership do not need to file any papers or pay any fees to set up a partnership. The partnership begins when you start a business with one or more other people. They might have an agreement, called a partnership agreement, to outline how they'll work together.
Also, like a sole proprietorship, each partner will report their share of the business profits on their personal tax returns as income. Partnerships don't pay business taxes themselves. Instead, the income and losses are passed to the individual partners. Each partner is personally liable for any debts, claims, or other liabilities that the business is liable for. However, like sole proprietors, partners might face self-employment taxes.
Limited partnerships (LPs) are slightly different than general partnerships. Limited partnerships cost money and can be difficult to set up. LPs have both general partners and limited partners. General partners manage the business and handle day-to-day operations. They make decisions, oversee activities, and are the face of the business. They have a higher degree of responsibility as a general partner.
General partners assume liability for debts incurred by the LP. General partners in an LP share in the business profits. They report the income on their personal income taxes.
Limited partners, in contrast, have a more passive role. They contribute capital. They are not involved in daily operations. LPs enjoy a shield from personal liability involving the partnership's debts or legal issues. They have less liability than general partners. Their liability is generally limited to the amount they've invested in the business. Limited partners share in the profits or losses of the business. Their share is dependent on their investment or the partnership agreement.
Limited Liability Partnerships
Limited liability partnerships (LLPs) blend features from both partnerships and corporations. One major advantage of an LLP is that profits and losses pass directly to the partners. This avoids the double taxation issue faced by some corporations.
In an LLP, partners enjoy protection from personal liability for business debts or actions taken by other partners. Partners take part in the business's operations, but their personal assets are typically shielded from potential business risks.
LLPs offer more flexibility than traditional corporations, but they are often subjected to specific state regulations. Their formation is often more suitable for certain individuals in specific professions. For example, LLPs are suitable for lawyers, accountants, and architects.
Limited Liability Companies
A limited liability company (LLC) combines the best features of corporations and partnerships. Business owners, known as members, enjoy protection from personal liability for company debts. This feature is like a corporation. This means that if the LLC faces financial or legal issues, members typically risk only their investment in the company. Their personal assets are not at risk. To learn more about forming an LLC, visit FindLaw's Forming an LLC page.
On the tax front, LLCs often operate more like partnerships. Instead of the company paying its own taxes, profits and losses pass through to members' personal tax returns. This structure provides flexibility and simplicity. Because of this, LLCs are a popular choice for many entrepreneurs and small business owners.
Corporations are a more formal business structure. This legal structure offers the most robust protection to their owners from personal liability. During incorporation, a business transforms into a distinct legal entity. This entity is separate from its founders or shareholders. There are different types of corporations, each with unique features.
A standard corporation is often referred to as a C corp. A C corp is a more traditional corporate structure. Corporations can take advantage of specific tax credits, depending on their activities and investments. C corporations are unique because they pay corporate taxes on their corporate income. These corporations are taxed at their specific corporate tax rates.
This can lead to double taxation since the owners, or shareholders, also pay taxes on distributions. A C corp also requires a board of directors and can issue different classes of stock.
Another type is the closed corporation. Unlike standard corporations, closed corporations have a limited number of shareholders. They do not adhere to the same stringent management structures. Instead of a board of directors, operating agreements guide decision-making.
A nonprofit corporation is formed with the aim of fulfilling a charitable or educational purpose. They can also fulfill a literary, religious, or scientific purpose. A nonprofit corporation can request charitable givings from the public. They can also seek to raise funds by seeking private grant money from companies and individuals.
For those looking to start a tax-exempt organization, a nonprofit organization is the way to go. While they do earn income, it's reinvested into their mission. After meeting specific criteria, the IRS can grant them tax-exempt status. This means they don't pay income tax, but they still must file an annual report. This is one of the biggest benefits of nonprofit corporations.
Cooperatives, or co-ops, are businesses owned and run by those who enjoy its services. Members of a co-op vote on business decisions and share profits. Co-ops might get tax benefits, like deductions or credits, depending on their activities and structure. They often focus on areas like agriculture, retail, or housing.
A co-op is a business that is most associated with grassroots organizations. These businesses are owned and operated by the members of the co-op in a democratic fashion. Much of the time, consumers form a co-op when they want to create a friendlier place of business. As such, these organizations often spring up in the form of a grocery store or a child care center.
There are some states that have written laws about the setup and operation of co-ops. If you would like to find out if your state has laws on co-ops, you should contact your secretary of state.
Learn More About Types of Business Structures by Talking to an Attorney
There are plenty of factors to take into consideration when choosing a business structure for your startup company. You may have questions about liability protection and business plans for future expansion. The best way to make an informed decision about your new company is to speak with a business organization lawyer. These attorneys can provide legal advice based on your specific situation.
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