Most businesses start out as a simple sole proprietorship. However, if your business is successful, you will probably start looking rethinking your business structure relatively soon. Sole props are fine in the beginning but, as you grow, you run a greater risk of tax complications and liability concerns. Most importantly, organizing your small business into an entity can protect your assets and help you project a more credible image. For example, if you have a sole proprietorship with liability risks, you should probably rethink your business structure. Make sure you watch the video above for a complete walkthrough because it provides information that’s not included in this blog post.
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Business Structure Basics
A business entity is a separate organization formed for the purpose of conducting business or holding assets. Above all, entities help facilitate business operations. They also organize the business’s ownership structure through established operating agreements that set roles and responsibilities for the owners. Ultimately, a business’s structure will affect taxes, legal liability for owners, compliance procedures, and much more.
There are several different types of business structures, so you must determine which is best for you. Common types of entities include sole proprietorship, partnership, LLCs, and corporations.
Common Entity Types
Each entity has various pros and cons, so it helps to consider your goals before you start shopping around. Some things to consider before setting up an entity are:
- Ownership structure
- Tax planning
- Liability risk
- Ease of administration
A sole proprietorship is the simplest entity to set up. It consists of a single member and administration is fairly simple. However, sole props offer no liability protection or tax benefits. Therefore, they’re not a good option for large businesses. For instance, if you have employees or you conduct business in a location that’s open to the public, a sole proprietorship is probably not the best option.
- Set up is easy and affordable
- No corporate taxes
- No annual reports or filings
- Personal liability
- No business continuity if something happens to you
- Can’t take on business debt
- Less professional credibility
Partnerships represent a basic agreement between two or more people to go into business together. In addition, each member must agree to cooperate for their mutual interests. Members can include individuals, businesses, or a combination of the two. However, partnerships do not offer liability protection. Partnerships are similar to sole proprietorships, but they have multiple members.
- Good for simple, multi-person businesses
- Reduced liability
- Pass-through income
- No filing requirements
- Individual taxation
- Not a legal entity
- No liability shield
Limited liability partnerships offer liability protection for its owners or partners. If one partner is sued, for example, the other partners are protected. LLPs are typically used by groups of certified or licensed professionals, like lawyers, CPAs, or doctors. As a result, LLPs aren’t suitable for most businesses.
- Liability based on investment
- No corporate tax
- Separation of legal entity
- Limited to certain professional groups.
- Complicated compliance procedures and self-employment taxes.
- Some states don’t recognize ‘foreign’ LLPs.
Limited liability companies have a simple tax structure, and they also offer liability protection for owners. LLCs are one of the simplest and most affordable business structures. Plus, compliance is relatively easy, so you can probably fulfill the filing requirements without the help fo a professional accountant.
- Protects personal assets
- Easy to form and maintain
- Flexible tax structure
- No limit on the number of members
- No limit on member distributions
- Annual fees
- Self-employed and excise tax
- Tax forms can be complicated
An S corp is similar to an LLC because it’s also a pass-through entity. The “S” represents the IRS code section that stipulates pass-through taxation to shareholders. Under an S corp, shareholders are only taxed at the individual level, so there are no corporate taxes. As a result, the pass-through structure allows shareholders to avoid double-taxation.
- Limits liability for management and shareholders
- Court-recognized existence
- Flow-through taxation
- Easy income splitting
- Only US citizens can hold shares.
- As a result of passthrough taxation, high-income shareholders could pay more.
- Limited to one class of stock.
C corps are a legal business entity that is entirely separate from its shareholders. The “C” refers to IRS code C and specifies that the organization is subject to double-taxes. The company has to pay taxes on its earnings, and shareholders must also pay taxes for receiving distributions from the entity.
- C Corps can have more shareholders than S Corps.
- There are no restrictions on international ownership.
- You can form create complex ownership structures with various classes of shares.
- Access to more deductions.
- Highest level of liability protection.
- Added Tax flexibility.
- More complex than an LLC or S Corp.
- Compliance can be complicated.
- Subject to Double taxation.
Finding the Best Option for Your Business
Ultimately, the best business structure for you depends on your company and your goals. However, if you need help choosing a business structure that fits, the accounting pros at Shared Economy Tax can help. Get started today with a free one-on-one strategy session with one of our tax advisors. You can also subscribe to our newsletter using the form below for more free tax tips.