Trying to decide what business to form? 

Before you flip a coin and sign the papers, have you truly asked yourself which business structure is right for your company?

Choosing the right structure is one of the most impactful early decisions that you will make as a new business.

Figuring out the best structure for your business can be frustrating. Don’t let it get to you, we’re here to help.

We are going to shine a light on the main business structures available. In this article, we will show you what you need to know to ensure that you pick the right business structure for your company.

Let’s dive in!

Business Structure Basics

Out of all the decisions that you will make as a business owner choosing the right struct is one of the most important decisions early on.

The business structure that you choose will have a major effect on the personal liability that you have, the taxes that you will pay, and the paperwork that you will have to fill out.

The most common business structures are: 

  1. Sole Proprietor
  2. Limited Liability Company (LLC)
  3. Corporation
    • C Corp   
    • S Corp

Choosing the most appropriate business structure really falls on the knowledge you have within your industry. 

Business Structure: Quick Comparison

Before we truly understand each business structure lets take a look at a general comparison of the main business structures.

Business StructureOwnershipLiability Taxes
Sole Proprietorsingle personowner is personal liabilitypass-through taxation
Limited Liability Company 1 or moreowner/s are not personally liablepass-through taxation
C-Corp1 or moreowner/s are not personally liablecorporate tax
S-Corp1 or more, less than 100 membersowner/s are not personally liablepass-through taxation

Now that we have a taste of the differences and similarities of the most popular business structures, it’s time to break them down one by one. 

We are going to see how these business structures affect your personal liability, the taxes you must pay and the documentation required. 

1. Sole Proprietor 

The most common business type is a sole proprietor. It’s no surprise that a sole proprietor is the most simple structure to create.

As a sole proprietor you are your business, there is no separation. This structure is formed in a way that the owner is 100% responsible for the asset and liabilities of the business.

Personal Liability: With a sole proprietor, you are your business. With this business structure, you are fully responsible for the business in every way.

Taxation: A sole proprietor is taxed at the business owner’s tax bracket. That is the same bracket you would be taxed if you were employed. This is called pass-through taxation.

Documentation Requirements: A sole proprietor is an unincorporated business. The paperwork required is minimal.

Upside

  • Low cost to create- Varies depending on the state
  • Quick setup- Most simple structure
  • Easy tax filing- You are your business, simply file a 1040 IRS form

Downside

  • Personal assets are at risk- With a Sole proprietor you are your business and you are responsible

2. Limited Liability Company 

A Limited Liability company “AKA LLC” is a very common business structure.

An LLC is a great business to form if you’re looking to limit personal liability while taking advantage of pass-through taxation. 

Personal Liability: An LLC is a great way to build a “wall” between the owner/s (known as members) personal assets and the company’s financial liabilities.

Taxation: An LLC is not responsible for reporting taxes on its profits. The LLC owner/s report their share of profit on their personal tax return. 

Documentation Requirements: Different states require diverse paperwork. For the most part, it’s nothing out of proportion. Depending on your industry/state licenses and permits may vary.

Upside

  • Limited Liability- There is protection for members of an LLC
  • Flow-through taxation- profits go directly to members and are taxed at their tax brackets 
  • Less paperwork- Setting up an LLC is fairly easy

Downside   

  • Higher cost- Forming an LLC is expensive (depending on the state) compared to a sole proprietor

3. Corporation 

A corporation is an organization of people recognized by the state as a single entity. Forming a corporation is a bit more difficult than setting up the other business structures mentioned above.

We are going to look at C-Corps and S-Corps.

C-Corp

A C-Corp is the most common form of a corporation, it’s actually the default structure for an incorporated business. 

Like most of the other structures, a C-Corp is a separate legal entity from its owners and has a basic functioning structure (shareholders, directors, and employees).

Personal Liability: A C-Corp protects owners, shareholders, and employees from personal liability.

Taxation: This business structure is required to pay corporate tax. If the board of directors decides to distribute dividends, those receiving will pay capital gain tax. This is called double taxation

Documentation Requirements: A C-Corp is a highly regulated entity, therefore there is a fair share of paperwork that is required. 

Upside

  • Tax deductions- There is a wide range of expenses and tax deductions which are recognized by the IRS
  • Unlimited shareholders- A C-Corp can have as many shareholders as it wants from all over the world
  • Limited liability- Great protection for shareholders, directors, and employees

Downside

  • Increased paperwork- As mentioned before, a C-Corp is a highly regulated business structure, therefore there are strict regulations and a good deal of documentation requirements. 

S-Corps

Like a C-Corp, an S-Corp has a basic functioning structure with shareholders, directors, and employees. An S-Corp also offers very high protection. 

An S-Corp is unique because of the way the entity is taxed and because there is a restriction to the number of shareholders (no more than 100 shareholders in an S-Corp). 

Personal Liability: There isn’t much difference between the personal liability of a C-Corp and an S-Corp. This Business structure protects the personal liability of management. 

Taxation: This entity isn’t taxed at the corporate level, rather the shareholders are taxed according to their personal tax brackets. 

Documentation Requirements: Corporations are highly regulated entities. They are responsible for maintaining corporate documentation which can get rather laborious. 

Upside

  • Limited liability-An S-Corp protects the shareholders, directors, and employees of the company 
  • Pass-through taxation- Just like LLCs and a sole proprietor, an S-Corp does not pay corporate tax
  • Salary and Dividends- With this business structure owners can receive a salary and dividends from the corporation

Downside

  • Strict requirements – To establish and keep an S-Corp there are strict requirements 

What’s Right For You?

Now that you understand the difference between the major business structures, you’re ready to tackle the legal phase!

Choosing the best structure for your business depends on your long term financial goals. If you are still unsure make sure you seriously consider your personal liability, tax obligations, and paperwork requirements involved.

The right type of business structure has much to do with your specific business needs. There is no generic company formation answer for all businesses.

If you are still stuck you speak to a local lawyer or a CPA.