It can be difficult to choose the right business structure, especially if you’re just starting out on your entrepreneurial journey and you’re not sure which type of company you want to run. While each business structure has its advantages and disadvantages, this guide will help you figure out which one best suits your needs by explaining the main types of business structures available to new entrepreneurs like yourself, as well as detailing the pros and cons of each.
A sole proprietorship is simply a business owned by one person. A sole proprietor has unlimited personal liability for all debts and obligations incurred by their business; i.e., they’re personally responsible for any and all losses. This means that their personal assets are on the line in addition to those of their business – including any homes, cars, or other valuables they own.
Pros and Cons of Sole Proprietorship
A sole proprietorship is easy to form and you don’t have to register it with any government agency. You are personally liable for your business, meaning that if your business can’t pay its debts, then you as an individual will be on the hook to pay them instead. There are also some tax advantages—for example, you can deduct most types of losses from your personal income taxes. The downside? If your sole proprietorship goes under and there isn’t any money left over after paying off all of your bills, there’s no way to recover anything for yourself or your creditors. If possible, try to get someone else (like a bank) to guarantee that you won’t lose all of your own money if things go south.
LLC or Limited Liability Company
Limited liability companies (LLCs) are hybrid entities that have some characteristics of corporations, but are not quite as formal or complex. LLCs offer their owners what is called limited liability meaning that personal assets such as a home, savings accounts and investments are not at risk if your business is sued or files for bankruptcy. To start an LLC you must file articles of organization with your state government along with filing fees. The process varies by state, but is generally simple and can be completed online.
Pros and Cons of Limited Liability Corporations
Limited liability corporations (LLCs) are owned by shareholders, who may be individuals or other business entities. LLCs can also have one owner, or member. Members have limited personal liability for an LLC's debts and obligations under federal and state law; however, members can lose their investment in a LLC if they fail to follow formalities established by state law. LLCs may choose to organize as either disregarded entities (in which case they do not have to file formation documents with a state agency) or as corporations for tax purposes. Organizing as a corporation allows an LLC to obtain favorable tax treatment.
A Sub S corporation is a business structure that allows corporations to pass corporate income, losses, deductions, and credit through to their shareholders for federal tax purposes. Sub S corporations are advantageous for small businesses because they allow maximum flexibility in determining how income and losses will be passed through to shareholders. This means that these businesses can elect what type of profit distributions they want to give their owners. Furthermore, no income is taxed at a corporate level, only at an individual level. Therefore, sub S corporations offer limited liability protection and low administrative costs as well as favorable tax treatment. If you’re looking into forming a small business with limited liability protection and other favorable tax treatment while maintaining flexibility in profit distribution decisions, consider setting up a sub S corporation.
Pros and Cons of S Corp
The Sub S Corporation (S Corp) is another common business structure. Like an LLC, it has pass-through taxation, meaning that it isn’t taxed at a corporate level. Rather, individual shareholders are taxed on their share of company profits. Shareholders also have more flexibility than they do in a corporation—they can hire employees, loan money to the company and sell shares as they please. However, there are some downsides to an S Corp: shareholder salaries count toward taxable income, which means that even if you don’t take a salary from your corporation (which would seem silly), you will still have to pay taxes on what amounts to phantom income for someone who owns his or her own business.
If you plan to raise outside capital and grow your business quickly, consider incorporating as a C Corp. C Corps are required to file an annual statement with the IRS detailing profits and losses. This is important for raising venture capital, selling shares to other companies, or providing investors with annual financial statements. C Corps do have their drawbacks: namely that they are pass-through entities (as opposed to corporate entities) so that all income is passed through to shareholders and becomes taxed at their personal tax rate.
Pros and Cons of C Corp
This type of business structure is popular among big companies, but it comes with some significant downsides. Your personal assets may be subject to claims by creditors, even if you’re not personally liable for a company’s debt or obligations. And you’ll need to pay self-employment taxes on all corporate profits. However, corporations offer a number of benefits that other structures don’t: they can span multiple states and countries, they can be easily sold (even while you’re running them), and they provide more legal protection than other types of business structures. For more on how incorporating your business affects taxes, visit IRS.gov/Businesses/Corporations.
There are a variety of business structures, each with their own unique pros and cons. For example, in an LLC (Limited Liability Company), personal assets can't be touched by company creditors. But, it costs money to register for an LLC, and there's also paperwork associated with taxes. An S-Corp has similar liability protections but avoids registration fees and paperwork; however, profits from an S-Corp must be reported on a separate form that must be filed annually with federal authorities (the IRS). As you weigh your options as a budding entrepreneur, look at what resources you already have available—and evaluate which one will serve your business needs best.