The Best Business Structures to Consider for Tax and Legal Purposes

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Different types of business formations for a small business owner

Which business structure is best? There are several types of legal structures to choose from, each with its unique benefits and challenges. It’s a good idea to familiarize yourself with all the options when you’re setting up a new company so you can select the right structure for your needs and make sure it will suit you in the long run too. We’ll give you a quick overview of the options and some tips to help you choose the best one below.

Choosing a Business Structure That’s Right for You

First and foremost, your business structure impacts how much you’ll pay in taxes and how your taxes are paid, plus determines your personal liability for business-related issues. It also affects how you can raise money and the types of paperwork you file. With that in mind, there’s no singular “best” business structure. Instead, you’ll want to choose the one that aligns with your business needs.

Can My Business Structure be Changed?

Before we begin, it’s important to note that the ability to change a business structure depends on the structure you’re presently using. It works in a linear fashion. For example, if you start with a structure designed for one owner, you can change it later to include multiple business owners or to a more advanced level. However, if you’re running a corporation, you cannot change the structure later. You’d have to dissolve the corporation and create a new business. For that reason, it’s always a good idea to speak with an attorney and/or accountant specializing in business matters.

Different Types of Business Structures

Sole Proprietorship

Sole proprietors have total control and ownership of their companies. With more than 23 million sole proprietors across the United States, this is the most popular option for small businesses per Small Biz Trends. All assets and liabilities are exclusively yours and indistinguishable from your personal assets and liabilities. You’ll even pay taxes, under ordinary income tax rates, on your business earnings when you file your personal tax returns rather than paying taxes separately as a business. This is known as pass-through taxation or flow-through taxation.

It’s easy to file sole proprietorship paperwork. Your business will automatically be designated as one if you’re doing business alone as well. You can operate under a trade name or “doing business as” (DBA) name for professionalism or privacy too. However, raising money as a sole proprietor can be more difficult as banks and investors are a bit more hesitant to lend, and you can’t sell stock.

Partnership

Partnerships are the simplest business structure for two or more people. Though there are several types that vary in form and function, taxes are managed through personal returns in all of them, but sometimes there are additional IRS requirements.

  • The general partner has unlimited liability and must pay self-employment taxes, but also typically has more control over the company than the limited partners do.
  • Only certain types of professional service businesses qualify for this designation. The list varies by state but typically includes professionals like doctors, attorneys, accountants, and so forth.
  • Limited Liability Limited Partnership (LLLP): There’s a gap between LPs (Limited Partnerships) and LLPs (Limited Liability Partnerships) that leaves general partners unprotected from business issues. In the past, some businesses would create an LLC to serve as the general partner to avoid the risk. Nowadays, some states allow the creation of an LLLP to serve the same purpose.

Filing partnership documents for any of these arrangements is comparatively easy. However, it’s always a good idea to have an attorney examine the partnership agreement to ensure there are no questions or misunderstandings about the rights, privileges, and profits any partner will receive.

Corporation

A corporation is a distinct legal entity from its owners and has its own rights. There are several types of corporations.

C Corporations: A C corp can own and sell property and sue or be sued. It’s also responsible for paying income tax. This is done when the profit is made and when dividends are paid to shareholders too. Corporations can raise money through the sale of stocks and usually have an easier time getting funding from banks and other sources. However, it’s more expensive to form corporations compared to other options. A C  Corporation is not only subject to corporate income tax, but its owners must still pay personal income tax on profits (known as double taxation). Plus, there’s less flexibility for management as corporations are required to have a board of directors, and additional recordkeeping is involved.

S Corporations: S corps are the most common business structure for small businesses with employees. The biggest benefit to running an S corp over a C corp is that double taxation of profits is not an issue. Only shareholders pay taxes on profits received. However, there are additional requirements to file as an S corp, such as all shareholders need to be U.S. residents. There are limits set on how stocks are handled too. For example, there can only be a maximum of 100 shareholders, and owners can only get common stock.

B Corporations: Sometimes referred to as a benefit corporation, a B corp is guided by a societal mission. It aims to generate profit and provide some kind of public benefit. Taxation is the same as with a C corp. However, B corps can qualify for additional certifications that can shape public perception and sometimes qualify for special programs or discounts.

Limited Liability Company

A limited liability company (LLC) is similar to a hybrid between a partnership and a corporation, though you can also form one alone. Your personal assets are largely protected under an LLC, and double taxation is not an issue. Taxes on profits are paid by the individuals on their personal returns rather than at the corporate level. However, all members of an LLC must pay self-employment taxes and contribute to Medicare and Social Security.

Guidelines vary quite a bit at the state level, so it’s a good idea to check your local laws to see how they’ll impact your business before settling on an LLC.

Cooperative

Cooperatives are unique in that they’re owned and operated by a group of members for their own benefit. These members, known as user-owners, usually vote in a board of directors who make decisions for the cooperative. Any profits are split, and taxes are paid as a pass-through.

Best Type of Business Entity for Tax and Legal Purposes

There’s no single best type of business entity. But, again, each one comes with unique advantages and disadvantages, so you’ll have to familiarize yourself with them all and see what fits best with your business needs. The highlights are covered below.

Considerations Before Choosing a Business Structure

As you’re deciding which business structure to choose, consider the following questions:

  • Am I ok with being held personally liable for my business debts or lawsuits?
  • Do I want to retain total control of my company, or am I ok with a board making decisions?
  • Does the option I’m considering minimize my tax liabilities?
  • Will I be able to get the funding my business needs with this business structure?

Get the Funding You Need at Any Stage

Small businesses often have a difficult time getting the funding they need to grow based on the type of legal structure they choose. At the same time, it’s not always best for the business to move to a more advanced business structure, as moving can drain resources and reduce the amount of control you have over your business. If your company is struggling with funding issues, consider invoice factoring. It’s like getting an advance on your unpaid B2B invoices, except your clients pay the factoring company rather than you after you’re funded, so you don’t accrue debt and are free to move forward. To learn more, request a complimentary rate quote from Charter Capital.

 

DISCLAIMER: This article is not intended to provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

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