Deciding to start your own business is an exciting and momentous time in anyone’s life. However, taking your ideas and turning them into a tangible reality is a big step. When you take that step, you want to make sure that you thoroughly think through the organizational needs of your future business and what structure might best help it to thrive. When making this decision, it is essential to think of your business’s anticipated size, purpose and goals. Ultimately, the structure you select for your business will influence any number of things – from taxes to how you operate daily and even what portion of your personal assets are at risk. Therefore, it is important to thoroughly consider all your options and seek qualified legal counsel and tax advice as to the structure that might best serve you.
Before registering your business, you will need to decide on the business structure. Some of the most used include:
- Sole Proprietorship: A sole proprietorship is essentially the default structure of a business in a situation where someone conducts business activities but does not register as any other kind of business. It is not considered a separate business “entity,” which means that the assets and liabilities of the business are not separate from the owner’s assets and liabilities. Sole proprietorships are often a wise choice for those individuals who have a low-risk business idea that they want to test before creating a more formalized type of business structure.
- Partnership: Partnerships are often considered the simplest type of business organization for two people, or more as the case may be, who wish to go into business together. A partnership is a good structure for those businesses with more than one owner and professionals, including attorneys, engineers or architects. It’s best for groups who want to begin their businesses at a slightly less formal level than a corporate structure. There are two frequently utilized types of partnerships:
o Limited Partnerships (LP): Limited partnerships only have one general partner who has unlimited liability and who pays self-employment taxes. The other partners in the partnership have what is considered “limited” liability and a more limited controlling role in the company. This sort of arrangement is typically outlined in a partnership agreement, and profits from this sort of arrangement are included on personal tax returns.
o Limited Liability Partnerships (LLP): These partnerships are similar to limited partnerships, although each owner under this structure has limited liability. As a result, each partner is protected from the partnership’s debts and will not be liable for the actions taken by the other partners.
- Limited Liability Company (LLC): In essence, a limited liability company combines the benefits offered by the partnership and corporate organizational structures. In the majority of instances, the personal assets of LLC members are protected from liability. In an LLC, any profits or losses are passed through to personal income. This means that the LLC structure essentially limits corporate taxes. However, most members of an LLC are viewed as being self-employed for tax purposes and must therefore pay self-employment taxes. For those considered medium or higher risk, who have members with significant personal assets that they would like to protect, or for owners who would want to pay at a lesser tax rate than they would under a corporate structure, an LLC can be an excellent choice.
- Corporation: Often considered the most formal type of business structure, corporations provide strong protections to shield owners from personal liability, though in exchange, they also require significant and detailed record-keeping and reporting requirements in addition to having more detailed operating processes. Unlike the business structure mentioned above, corporations generally pay income taxes on profits. However, there are some exceptions to this rule, which an attorney can explain to you in detail should you be interested in this type of business structure. In some cases, corporations can be taxed more than once – the first time, when a profit is initially made, and then a second time, when dividends are paid to shareholders and included on their tax returns. A corporation and its shareholders are considered separate entities, such that if a shareholder sells their shares, the corporation will continue conducting business as usual. Two of the most common types of corporate structures include:
o C Corp: A C Corporation is the most general type of corporation. It has all the characteristics outlined above, and it is an entity distinct from its owners. A C Corp can earn a profit, have legal liability, and be taxed.
o S Corp: An S Corporation is a corporation intentionally structured to avoid the double taxation often applicable to C corporations. An S Corporation is structured for some of the profits and losses to pass through directly to the owners’ personal income without being subject to corporate tax rates. Additionally, S corps have special limits – a limited number of shareholders, certain filing and particular operational processes, and other necessary characteristics.
Corporations are generally a beneficial structure for businesses that are either medium or high risk, need to raise money or businesses that eventually plan to be sold or go public.
- Non-Profit Corporation: Nonprofit corporations are organized for charitable, educational, religious or scientific work. As their work is intended to provide a public benefit, they can receive tax-exempt status, which they must request and receive from the IRS. Nonprofits follow rules similar to a regular C Corporation in many respects.
- Cooperative: This is a business structure owned and operated specifically to benefit those utilizing its services. Under this structure, earnings generated by the cooperative are distributed between the members, who are often called user-owners. A board of directors often runs cooperatives, and their officers are chosen through an election.
Jonathan Schmidt is the principal attorney with 303 Legal, P.C. He practices in the areas of business and litigation. He can be contacted at firstname.lastname@example.org or www.303.legal.