Choosing Business Structure for Small Business
24 August, 2020
There are a lot of choices that you need to make when starting a business. And one of the most important ones is choosing the business structure. In fact, this decision would affect a lot of things about your company such as the amount of paperwork you would need, the amount of taxes you will pay and the personal liability you face and the ability to raise money too.
Due to this, it is not a decision to be made lightly. This article would help you understand all about the different types of business entities. After the proper knowledge about it, you will then be able to decide which one is perfect for your business idea and goal. Keep reading to understand all better.
A business structure is the organization of the business in regard to its legal status. Selecting the most appropriate business structure would build a legal recognition for your trade. In addition to this, the business structure also takes care of all the other things that are very important to run a business. For example, it offers the best approach to deal with all tax liabilities.
Along with this, you get to learn about your responsibilities and duties as a business owner. It enlightens you more about all the legal documentation that you need. But do keep in mind that this also depends on the jurisdiction in which your company will be located. What's more imperative, is that it would let you know all about the personal liabilities that will incur for the owners and partners. You will also have to consider all the money you will spend on setting up the company and also for maintaining it. In short, each business structure you choose has its own costs and rules.
What are the common business structures?
There are many types of business entities in the USA, but the most common ones include the limited liability company (LLC), partnership, sole proprietorship and some other kinds of corporations called the standard corporation also called the C corporation, and the small business corporation called the S corporation.
Choosing Business Structure
It is important to note that while you choose your business structure, you need to ensure that it meets your business needs for a long time and not just at that time. For instance, do not choose a sole proprietorship just since you won't spend much to set it up when you want to expand your company. In this case, a corporation is a good idea. The bottom line is that - do not take this very important decision lightly. And make a choice that would help you. Consider all the needs of your business and its owners and then choose the business structure.
To help you make the choice, each of the main structures have been explained below.
Let us assume that your business gets into trouble and you are held responsible for all the losses, would it be okay with you? No, right? No one wants to lose their personal assets to a business loss. No one wants to get on the road when their business fails or gets in trouble. Well, that is why the LLC was created. And the best part about the LLC is that it has the best of both the worlds including the flexibility of the sole proprietorship and the liability protection of the corporation.
The LLC has its own choice to choose how it is taxed. This means that the LLC can be taxed as a C corporation, where they pay taxes on both the corporate and personal level, and enjoy a lot of deductions. On the other hand, they can be taxed as the S corporation where they can easily pay taxes on the personal level and avoid the double taxation issues that the C corporation faces. So, if personal liability is something you need and you also want to enjoy being taxed as you like, then choose this business structure.
How to form an LLC?
The process to form an LLC is a lot more complex than setting up a sole proprietorship or a partnership. You will need to select a proper business name that follows the rules, file the articles of organization, and create an operating agreement. Along with this, based on the kind of business you are operating, you will also need the specific licenses and permits as per the government requirements.
With this said, here are a few things you need to know about an LLC that will help you decide if you should choose this business entity or not:
- Almost all the states allow you to form an LLC with just one member. So, you do not need many people to form an LLC. Based on your situation, an LLC can be a great option instead of a sole proprietorship.
- You get to choose how you are taxed - where entrepreneurs usually choose to be taxed as the S corporation, that is, the owner/owners will pay tax on the profits they get from the business on their personal tax returns.
- Even though you are offered limited liability protection, there is a lot of difficulty that comes as well. Basically, forming an LLC costs a lot more, is more time consuming and complex to form as compared to the sole proprietorship. But this should not stop you from choosing this as it is the best out of all the types of business entity.
The moment people hear the phrase "types of business entity," the first structure that comes to their mind is the corporation. This is a much more complex legal structure with many shareholders and more intricate tax requirements. There are three kinds of corporations - the standard C corporation, the small business S corporation, and the benefit corporation or B corp. Out of the three - C corporations are the most successful ones and then comes the S corporation.
A corporation is a great choice for those who want to expand and one day make their company go public. If you are not looking for such a business, then do not choose this business structure. In fact, a corporation allows you to have many employees,sell stock of the company, scale quickly, and have many outside investors.
How do you form a corporation?
To be able to form a corporation, you will have to register your business name. This means that you will need to file your articles of incorporation. Once you have done this, you will also have to get the Federal Tax Information that is also called the EIN or the employer identification number.
As mentioned above, there are different kinds of corporations - C corporation, S corporation and the B corporation. Each has been explained below.
In a C corporation, all the shareholders combine the funds and are given stock in a newly formed business. In fact, the C corporation is a completely separate tax entity in the eyes of the IRS and the company can easily deduct the various business expenses on the corporate tax return form. But this also means that the earnings from the company are taxed twice, both from the corporate level and the personal level when divided amongst the shareholders.
There is a way out of this where good tax planning can easily minimize the influence of the double taxation issue. In addition to this, the C corporation offers the best shielding to the owners from personal liability along with many non-tax benefits that would help the company eventually become public. By choosing to open a C corporation, you are choosing to gain credibility that would allow you to easily raise outside capital as well. It is the best choice for those who want to grow their business into an empire.
An S corporation is a bit different as compared to the C corporation. In fact, one of the main differences is that the profits and losses can be passed-through and paid for on the owners'/shareholders' personal tax return. This means that there is no double taxation issue in this business entity unlike the C corporation. And those who want to keep the company in their family or do not want to go public can choose this business structure.
You should also know that the S corporation sends a lot of profits home to the owners unlike the C corporation that doesn't send much because it is used to grow the company. The S corporation is usually owned by a specific number of owners who are individuals and not a business entity, which is unlike the C corporation that allows any individual and even companies to be a shareholder in the C corporation.
For your company to be an S corporation, you will first have to set it up as a corporation, where by default it would be a C corporation. After this, you will need to request for the S corporation status using the Form 2553.
If your company has a dedicated social mission, then the B corporation is a great choice for you. B Corporation stands for "Benefit Corporation." Although the name is different from the other corporations, it is just like the C corporation. In short, it is just a C corporation that has been approved to have the B corporation status. Not all, but some states also offer the B corporations tax breaks so that they can stand behind their cause.
Sounds a lot like the nonprofit? Well, it is not since in the B corporation there are owners and shareholders while in the nonprofit there are no shareholders or owners. So, the B corporation is still a for-profit company where the profits go to the shareholders at the end, but the company follows a social cause.
Things you be aware of
Although the corporation is a great choice, it is not the best for everyone. Here are some things you need to be aware of before you choose this business structure:
- Corporations can easily raise capital by selling their stocks to potential investors.
- It offers the most limited liability protection where the personal assets of the shareholders are not touched regardless of what happens in the company.
- The corporate taxes are filed separately from the personal taxes, which allows the corporation to gain many business tax benefits and deductions.
- It is quite difficult to set up a corporation due to its complicated structure and the large number of official papers that have to be filed.
- Double taxation is an issue for the C corporation unless you elect to be taxed as the S corporation. But this would mean that you would not get the corporate tax benefits and you would not be able to have many shareholders to eventually take the company public.
From all the types of business entities, the simplest one is the sole proprietorship. When you do not create a separate legal entity for your business, it is called sole proprietorship. You can operate the business under your name or a trade name under this business entity type. It is simple and inexpensive to set up. But it doesn't offer any protection to your personal assets as the other legal entities do. So, if your company is sued, your personal assets can be used to pay all the creditors.
How to form a sole proprietorship?
It is very easy to form a sole proprietorship as there is no official registration required. So, if you are already taking plumbing contracts in the area and working on it, congratulations, you are a sole proprietor. Nonetheless, remember to get the needed licenses and permits based on your industry from the government. Check with your lawyer for more details. Also, if you want to do business that is not under your own name but a trade name, then you will need to file a DBA, which is known as "doing business as".
Here are the things you need to be aware of before you choose this business entity:
- It is inexpensive. If you want to use a trade name, that is the only time you will need to spend a little to file for the DBA, else you won't have to spend anything on setting your business up.
- The taxes would be simple as the profits and losses pass-through and the tax is paid for, on your personal income tax.
- You can have employees and it would make your taxes a little more complicated, but not so much.
- You would find it highly difficult to raise money for your business or grow it.
- Getting loans would be a huge headache and in some cases, you might not get it.
- The owners are liable for any business fails and would need to use their personal assets to pay off all the debts or fees it incurs.
The last main kind of business entity from all the types of business entities is the partnership. It is a lot like the sole proprietorship but with more than one person.
They too are very simple but it is important to have a partnership agreement in such a business entity. Also, a partnership is governed by the state laws which is the Uniform Partnership Act in many states. In fact, there are different kinds of partnerships, based on the agreement created. They include:
- General Partnership: In this, all parties are equally involved where they get equal profits, losses, and it is the same for the duties and liabilities as well. If there is an unequal split, it should be noted in the official partnership agreement.
- Limited Partnership: This is for the partners who serve an investor role only and have limited input in actually running the company. It is a complex structure and isn't used a lot.
- Joint Venture: If you want to partner for a specific project only, then the joint venture is a great option.
How are partnerships formed?
Just like the sole proprietorship, by just doing business together forms a partnership. But if you want to use a trade name, you will need to file a DBA. Also, based on your industry, you might also need some permits and licenses. Contact your lawyer to know more.
Before you choose this business structure, here are some things you should be aware of:
- You need a partnership agreement when starting a partnership to make sure there is no trouble later on. But this costs you since you would need a lawyer to have it prepared properly.
- Partnerships offer the pass-through benefit for all the profits and losses generated in the business.
- You need to ensure that your partner is a trustworthy person in this kind of business, as it can cost you a lot if they create an issue and vanish. Do a proper background check before partnering.
How can IncParadise help you?
You now know all the types of business entities available from which you can easily choose. Now, it is time for you to set it up. IncParadise can help you in incorporating your business. We also act as registered agents in every state in the US. So, all you need to do is contact us and we will discuss your case and help you out. Visit to know more!
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