How to Choose a Business Structure

“Quality is never an accident. It is always the result of intelligent effort.”

– John Ruskin

---

This is a small section from my post about Building a Business Plan. In January, 2022, I decided to commit to building a company, and it was one component of the process. You can check out the full project here.

---

The structure of your business determines its taxes, your personal liability, necessary paperwork, and raising money.

Business Structures

Sole Proprietorship

• Gives you complete control of your business
• Does not produce a separate business entity which means that your assets and liabilities under this Sole Proprietorship are not separate from your personal assets and liabilities. 
• You can be held personally liable for the debts and obligations of the business.
• You can’t sell stock
• Banks are more hesitant to loan to Sole Proprietorships
• Can be a good choice for low-risk businesses

Partnerships

Partnerships are a good choice for professional groups who either want to test an idea, or don’t want to do it on a large scale. There are two types of Partnerships: Limited Partnerships (LP) and Limited Liability Partnerships (LLP).

Limited Partnership (LP)

• One General Partner with unlimited liability, and the other partners have limited liability 
  • Unlimited liability is the same as what a Sole Proprietorship has – full personal liability and responsibility for business affairs (debts, assets, etc.); must pay self-employment taxes as well
  • Limited liability is not full personal responsibility – liability can be divvied out in different ways, one of which, being percent value of equity in the business; has less control over the company than the unlimited liability member

Limited Liability Partnership (LLP)

• Similar to Limited Partnerships but gives limited liability to every owner 
• LLPs protect each individual partner from debts against the partnership. Additionally, no one partner must take responsibility for the actions of another. 

Limited Liability Corporation (LLC)

An LLC is like a mix between a sole proprietorship and a corporation in terms of business structure. It protects you from personal liability so, in most cases, regardless of what happens under the LLC, your personal belongings aren’t at risk. With an LLC, business profits and losses are reported on your personal income tax return rather than a business tax return which means you still have to pay a self-employment tax.

There are a few different types of LLCs.

Single-Member LLC

• Treated as sole proprietorships for tax purposes
• Owner and business seen as the same which means that your LLC profits are considered personal income rather than business income
• “Owner’s draw” is how owners pay themselves – instead of taking a conventional salary, the amount and frequency of draws is up to them, but it’s ideal that they leave enough to keep growing the business

Multi-Member LLC

• Treated as partnerships for tax purposes – business itself isn’t taxed.
• It’s seen as a “pass-through entity” which means that though the business income is officially reported to the IRS, each member’s share of the profits is treated as their personal income and taxed independently.
• Each member must also pay themselves through the owner’s draw method, but can set up a guaranteed payment which could act like a salary

Corporate LLC

• Owners have to formally request, or elect, to be established as a corp LLC
• Owners aren’t allowed to take owner’s draws, and instead are considered employees that must pay themselves a set salary on the company’s regular payroll with taxes withheld
• As a Corporate LLC owner, you can determine your salary, but it has to be reasonable – something similar to what someone hired in a similar position would make 
• In addition to your official salary, you can pay yourself distributions – payouts of the business’ equity to the owner, shareholder, or LLC member – or dividends – payout from the business’ profits

Corporation

The Corporation is the most complex business structure. It provides the strongest protection to its owners by separating liabilities and obligations that were incurred by the company from its owners. Corporations are regulated by the laws of the states they’re set up in, and they’re taxed as separate entities at corporate tax rates.

The different types of Corporations are:

C-Corp

• Legal entity separate from its owners 
• In some cases corp taxes can be taxed twice, first when the company profits, and then again when dividends are paid to shareholders on their personal tax returns

S-Corp

• Designed to avoid the double taxation of regular C-Corps
• Allows profits and some losses to be passed directly through an owner’s personal income without ever being subject to corporate tax rates
• Must register with the IRS and meet criteria

B-Corp

• For-profit corp recognized by a majority of U.S. states 
• Different from C-Corps in purpose, accountability, and transparency, but taxed the same (legal commitment to do a certain good)
• Driven by mission and profit 
• Shareholders hold the company accountable to produce some sort of public benefit in addition to financial profit

Close Corp

• Resemble B corps but have less traditional corporate structure 
• Shed formalities 
• Can be run by a small group of shareholders without a board of directors

Non-Profit Corp

• Organized to do charity, education, religious, literary, or scientific work 
• Work benefits the public 
• Can receive tax-exempt status – they don’t pay federal or state income tax on profits made
• Have to follow organizational rules that are similar to regular C-Corps

Cooperative

• Business or organization owned and operated to benefit those using its services 
• Profits distributed among user-owners (users are the owners)
• Elected board of directors and officers run 
• Regular members have voting power (become members by purchasing shares)

[If you want more information on any of the corporate structures, you can visit this government website.]