Deciding how to structure your business is one of the first decisions you’ll make as a business owner, and it’s a big one that can have long-term implications. Adopting some legal configuration to define the rights and liabilities of those participating in control, ownership and financial structure of a business, among other factors, is obligatory, and ultimately, determines which income tax return form to file.
Below is a brief overview of the different types of businesses to choose from, but for more specific detailed information, consult with an entity management company:
Sole proprietorship
With most businesses beginning life as a sole proprietorship, they are typically owned by one individual who may be an independent contractor or freelancer, or the owner of a home-based business.
What are the advantages of sole proprietorship?
- The individual owning the business gets all the profit
- Profits are taxed once
- The owner is in control of all business decisions
- It’s the most cost-effective and simple form of ownership to set up
Partnerships
Where ownership of a single business is shared by two or more individuals, the business and its owners are not distinguishable from each other by law; in much the same way as sole proprietorship. Legally binding agreements must be established to determine how business decisions are made, how profits will be shared, disputes resolved, future partners admitted to the partnership and existing ones bought out, along with how to dissolve the partnership if required.
What are the advantages of a partnership?
- Simple to establish
- Liability protection is afforded with separate legal status
- Profits are taxed once
- Partners may have multiple complementary skills
Corporations
Considered to be a unique entity in the eyes of the law, a corporation is separate from those who own it, and as such, can be taxed, sued and enter into contractual agreements. When ownership of a corporation changes, it does not dissolve and there are 3 different types: C-corporation, S-corporation and Limited Liability Company (LLC).
C-corporation
Taxed separately from its owners, a C-corporation offers limited liability; this has been known to encourage the taking of risks and potential investment.
What are the advantages of a C-corporation?
- Limited liability
- When ownership is transferred, shareholders can sell their shares
- The sale of stock makes it easier to raise capital
- Fringe benefits are paid by the company
- C-corporations have many tax benefits
S-corporation
Offering the businesses owners limited liability, S-corporations don’t pay income taxes; instead, the profits and earnings are treated as distributions. Shareholders must report their income on individual income tax returns.
What are the advantages of S-corporations?
- Limited liability
- Avoids double taxation
- Profits are taxed once
- Capital can easily be raised through stock sales
- It offers transfer of ownership
Limited Liability Company (LLC)
A hybrid business structure that gives the limited legal liability of a corporation coupled with the operational flexibility of a partnership or sole proprietorship, LLC’s are more complicated to formulate and are more formal than that of general partnerships.
What are the advantages of LLC’s?
- Created especially for small businesses, it’s the most common business structure
- Insurance is required in case legal action is taken out against it
- It is a separate legal entity
- LLC’s are typically taxed as a sole proprietorship
- LLC’s can have an unlimited number of owners
It’s important to get it right when deciding what type of business structure to use, and seeking professional help with both the making of the decision, and the formulating processes, is strongly recommended.