Selecting the best business structure for your new company is important for several reasons. Primarily, it determines tax classification and filing requirements. Business structures also address legal responsibilities for owners, partners, and managers. It is a very important decision that requires consultation with a tax expert and legal counsel.
Though this sounds intimidating, obtaining the most advice and counsel before making a decision is your first solid business decision. Key to operating a business, is seeking advice, information, and counsel for areas outside your ability.
Some business structures can change during the life of a business, others are inflexible and do not allow alteration. Keep this in mind as you read the summary of business types.
Business Structures – Find Your Type
There are six different structures to consider when forming your business.
1. Sole Proprietorship
This is the most basic and common business structure. It is individually owned and operated. The owner is responsible for all assets and liabilities (money in and money out). For tax purposes, in very basic terms, the owner is the business. This means the owner must report all financial information on their taxes. The owner takes all legal liability for the company too.
- Complete owner control
- Easy and inexpensive to form
- Taxes filed as the individual
- Owner personally responsible for all financial liabilities
- Owner personally responsible for all legal liabilities
- Difficulty to raise funds
2. Partnership (also Limited Liability Partnership)
A partnership is an option when the demands of the business need more than one person. It enables the partners to pull skills, talents, resources, and finances to start the business. However, a partnership agreement is highly recommended. It is an arrangement that establishes rules and what if solutions. The partners are personally liable and financial responsible for the company; similar to a sole proprietorship. A CPA or attorney can help filing any state and IRS forms.
- Shared work and financial responsibilities
- Easy and fairly inexpensive to form
- Taxes filed on partners individual tax returns
- Partners personally responsible for all financial liabilities
- Partners share personal liability
- Disagreements may develop
- Difficult to raise funds
3. Limited Liability Company
A LLC is a type of bridge between a partnership and corporation. This business type provides the legal liability protections of a corporation with the tax advantages of a partnership. LLC’s have members instead of shareholders or owners. Filing Articles of Organization are required in most states (check with your legal and tax consultants) and yearly filings may be required too. The profits are passed through to the members and not the corporation. And the members are protected from liability. A LLC requires an Operating Agreement, similar to Corporate Bylaws, to decide roles and responsibilities for the company.
- Limited liability for members
- Less paperwork compared to corporation status
- Profits shared and taxed between members
- Limited means the LLC is dissolved if a member leaves
- Members must pay self-employment taxes
- Yearly state filings to keep up status
A business owned and operated for the benefit of its users. All profits are distributed to members. A board is elected to govern the cooperative while members run the operation. Most common cooperatives are found in the farming industry (such as corn, poultry, wheat, cooperatives). Ranchers and farmers group together to create a cooperative. This collective venture gives the group more negotiation, borrowing, and selling power than individually.
- Must file Articles of Incorporation
- Establish Bylaws
- Conduct Member meetings and rules for accepting members
- Profits pass through to members and not the corporation
- Increased financial opportunities (including borrowing)
- Reduced costs because operations are shared
- Division of operation responsibilities
- Membership may be low, participation difficult to manage
- Cash flow challenges
This is a special type of corporation through an application to the IRS. The primary reason to file for S-Corp status is to avoid double taxation. Meaning taxation on the corporate level and again on the shareholder level. A business must first file as a corporation in their state, then apply for Subchapter S classification with the IRS. Though an S-Corp doesn’t protect shareholders from all liability, it does offer more protection than other business structures. The profits of an S-Corp pass through to the shareholders and not the corporation. This structure creates an independent entity; it is separate from the owners and exists independently.
- Lower tax liabilities (taxed on a personal level and not corporate)
- Independent of the shareholders
- Liability protections
- Borrowing opportunities increase
- More difficult and expensive to form
- Requires more paperwork and filing requirements
- Shareholders who work for the corporation must be paid (compensated) market value
The big daddy of business structures and formations. The C-Corp is possibly the most recognized business form. It is an independent entity, owned by shareholders, but existing separately from individuals. Capital is raised by selling shares (percentages of ownership in the corporation).
- Separate tax filing status (corporation and shareholders)
- Generate capital selling stock
- Liability protections
- Must elect a Board of Directors and hold Stockholder meetings
- Management and maintenance are costly and time-consuming (filings, legal requirements, regulations)
- Double taxation – profits taxes at a corporate level and a shareholder will pay income tax on any dividends
- More rules and regulations to abide
Regardless of the structure you are considering, it is always advisable to seen counsel. As mentioned, some structures are difficult to unwind (for instance corporations) and others can dissolve when certain events occur. Meet with an experienced CPA and lawyer to decide which structure is the right one for your business.