How to choose the right business structure
Choosing the right business structure is a big decision for your small business. It will affect how much you pay in taxes, the paperwork you need to file, the personal liability you face and more—all good reasons to get a firm grasp of what the different business structures offer.
Look no further as we’ve laid out the common business structures below so that you can compare them and gain confidence in selecting which is best for you and your business.
And be sure to consult with your attorney and accountant on this important decision, as well, before registering your business with your state.
This might be right for you if: 1) You want complete control of your business and are giving your business idea a test run; 2) You don’t mind being open to unlimited personal liability, which means there are no protections from being held liable if you are sued.
What you need to know: As a sole proprietor, your business is not considered a separate entity. As a result, you can be held personally liable for your business’s debts and obligations, which puts your personal assets (car, house, savings, etc.) at risk. Additionally, your business is not taxed separately like a corporation. Instead, you must report all business income and losses on your personal income tax return.
A sole proprietorship is easy to form and, in fact, is the business structure you’re automatically labeled if you do any kind of business activities but don’t register with your state.
This might be right for you if: You have two or more partners and want to pool your resources and capital to spread the risk of financial loss.
What you need to know: There are two kinds of partnerships: limited and limited liability.
A limited partnership entails one general partner who oversees the business and has full legal responsibility for business debts. A general partner’s earnings are considered self-employment and therefore are subject to a self-employment tax, which is the tax for Medicare and Social Security.
All other partners have limited liability, as well as limited control over the company, and profits and losses are passed to them and reported on their individual tax returns. The income of limited partners is not considered earned, so they are not required to pay self-employment taxes like the general partner.
A limited liability partnership gives limited liability to every owner, protecting each partner from being held responsible for the actions of other partners.
Limited liability company (LLC)
This might be right for you if: You want strong protection from personal liability and want to pay a lower tax than your company would as a corporation.
What you need to know: In most cases, your personal assets aren’t at risk if your LLC faces bankruptcy or a lawsuit. Your personal income isn’t subject to corporate taxes, but LLC owners are considered self-employed and must pay self-employment tax contributions toward Medicare and Social Security. Be sure to check your state’s requirements related to owners leaving or joining an LLC.
• C corp. This might be right for you if: Your business needs to raise capital and wants the option of bringing on investors. At the same time, you want to protect your personal assets.
What you need to know: A corporation, or C corp, is a legal entity separate from its owners, offers the strongest protection to its owners from personal liability, and can raise capital through the sale of stock. However, the cost to form a C corp is higher than other structures and requires more extensive record-keeping and reporting. For example, it’s a requirement to establish a board of directors and to hold at least one meeting a year for owners and the board, while keeping accurate meeting minutes.
Unique to a C corp is the double taxation of profits. The company as an entity pays a corporate income tax and the owners each pay a personal income tax on dividends.
• S corp. This might be right for you if: You’re considering a C corp structure but want to avoid being taxed twice.
What you need to know: S corp differs from a C corp in a few ways. First, an S corp’s profits are taxed only through owners’ personal tax returns and are not subject to corporate taxes. Not all states tax S corps equally so be sure to check your state’s requirements.
Second, in addition to registering with the state, an S corp must file with the IRS.
Third, an S corp must meet special requirements per the IRS. It can’t have more than 100 shareholders, all of whom must be U.S. citizens and may not be partnerships or corporations. And you can only have one class of stock, with shareholders having equal rights to distributions and to vote.
• A B corp is a certification that recognizes a for-profit company for its social and environmental impact. A company must complete an impact assessment and achieve a minimum score based on the company’s positive impact to the public.
There’s an annual certification fee that is based on a company’s revenue. A B corp is taxed similarly to a C corp but differs in that its shareholders hold the company accountable to producing a public benefit in addition to a financial profit.
• A close corporation has a less traditional corporate structure and can operate similar to a partnership. For example, annual meetings are not required and shareholders can override the directors.
Some requirements for meeting close corporation status include: a limit of shareholders (30 to 35 in most states), and a public offering of its stocks is not allowed.
• A nonprofit corporation is formed for charity, education, religious, literary, or scientific work. It can receive tax-exempt status, avoiding state or federal taxes on profits, by requesting 501(c)(3) status from the IRS. Once organized, a nonprofit must maintain compliance with the appropriate state agency that regulates charitable organizations.
Another important choice to make
Whatever structure you choose, you’ll need business insurance to protect you from unforeseen issues such as lawsuits, accidents, and natural disasters. Learn about small business options or speak with a Hiscox licensed insurance agent at 1-877-751-5310.