Business Structures Decoded: Understanding the Alphabet Soup of Business Structures

Choosing the Right Circus to Start: Business Structure Explained

Picking out the legal outfit for your business isn't like online shopping for leisure wear. Unlike sending back that shirt that looked more "raspberry sorbet" than "traffic cone orange" with free returns, a poor choice in business structure isn't so easy to reverse and could potentially leave you hurting (and not just in your fashion ego).

Summary of Key Points:

• Understanding the necessity and impacts of choosing the right legal structure for your business
  
• Breaking down the four common types of business structures: sole proprietorship, partnership, Limited Liability Company (LLC), and corporation
• Weighing the pros and cons of different business structures
  
• Exploring the details of tax implications, legal liabilities, and ongoing maintenance of the chosen business structure
  
• Pro tips and advice for startups deliberating on their business structure
  ‍
  

Choosing Your Business Structure: A Rumble in the Corporate Jungle

When starting a business, it can sometimes feel like you've accidentally picked up a second job called 'deciphering Legalese'. Before you throw in the towel, let's dive into the exciting world of business structures - or as I like to call it, the crazy quilt of commerce!

Your choice of business structure will have an impact on these and other aspects of running your company:

• Who qualifies to own your company
• Whether you can—and what you must do to–transfer ownership of your company
• Taxes your company is subject to
• Your ability to get credit and funding
• Your personal liability
• The number of ongoing compliance requirements you need to satisfy

Some of the factors that will influence which business entity type you select include:

• Where you plan to conduct your business
• Wanting to have limited personal liability for your business activities
• Whether you will have a partner or an investor
• Your expected earnings and deductions
• Desire to minimize your self-employment tax obligation
• Your business goals
• Your tolerance for compliance formalities
• Registration and administrative costs to set up and maintain a business structure

**Before selecting, though, you should talk with your accountant and attorney to determine which will best serve your needs.

‍

‍

‍

Sole Proprietorship: The Lone Ranger of Business

First up, we have the Sole Proprietorship. Your business is basically a legal extension of yourself. Imagine going to a party where you're the host, the DJ, and also the one cleaning the leftovers. Welcome to the world of Sole Proprietorship—you're the alpha and omega of your business. Good news is you get to enjoy all the profits. Bad news is, ALL the liabilities are on you, so you might wanna watch out for those party crashers!

In legal terms, in a Sole Proprietor, there is no legal separation between the business owner and the business. Property and liabilities are held in the owner’s name. Usually, the owner is an individual, but it could also be a married couple. Business taxes are filed as personal income using Schedule C.

So, if someone files a lawsuit against the company or the business can’t pay its debts, the owner’s personal assets (bank accounts, home, car, retirement savings, etc.) are at risk.

In most locations, starting a Sole Proprietorship may be as straightforward as filing a DBA (Doing Business As). Some licensing or permits might be required depending on the type and the location of the business. Otherwise, startup and ongoing compliance formalities are minimal.

When might operating as a Sole Proprietorship be preferable?

• When it’s a home-based business
• When a business has only one owner
• When a business has no employees
• When a business provides products and services that have minimal legal risks associated with them

‍

Partnerships: Three's a Crowd, But Two's a Company

Instead of the solo act, how about a duet?

Think Simon & Garfunkel. That's your partnership. It's all about sharing - profits, losses, and liabilities. You'll need to make sure to maintain harmony with your partner, or else you might end up singing out of tune. In terms of financial liability, it's pretty much in-sync with the sole proprietorship, but there are two of you handling it now. And oh, major ‘duets’ bonus: you also get to share the tax load.

In its simplest form, the Partnership structure mirrors a Sole Proprietorship. It is used when there will be more than one owner of the business.

In a General Partnership, owners share legal, financial, and management responsibilities for the business. In fact, the actions of one partner could impose liability on the personal assets of another partner.

Partners, with the help of their attorney, should have a detailed partnership agreement to spell out the division of ownership and duties. As with a Sole Proprietorship, there is no separation between the business and its owners. Business tax obligations pass through to the individual owners.

These variations offer more flexibility and liability protection. They also come with more formation and ongoing compliance requirements.

When might operating as a Partnership be preferable?

• When owners don’t intend to reinvest money back into the business
• When a multi-owner business doesn’t want to deal with compliance formalities
• When a multi-owner business has no employees
• When a business provides products and services that have minimal legal risks associated with them

‍

‍

LLC and Corporation: The Cool Cousins of Business Structure World

An LLC (Limited Liability Company) and Corporation are like the "Ivy League" of business structures, where you get some pretty cool benefits like limited liability and won’t have to sell your kidney if things go south. But remember, with great benefits come great tax forms!

C Corporation

C Corp is a confusing phrase to a lot of people. Really, the IRS uses this term “C-Corp” for the purpose of distinguishing a for-profit Corporation from one that has elected to be taxed as an S Corporation.

The Corporation is a legal entity separate from its owners, and it provides a significant degree of personal liability protection for its owners (shareholders). Ownership is through holding stock in the company, which may be held privately or publicly. The ability to sell stock in the business offers an opportunity to raise capital to fund initiatives and fuel growth. Status as a Corporation often makes a business more attractive to outside investors, as well.

A Corporation must file its own income tax return (IRS Form 1120). The company receives deductions for business expenses, which reduces its tax liability when it earns revenue. It may not deduct as an expense money paid to stockholders as dividends, and the individual stockholders who receive dividends must pay income tax on that income. The term “double taxation” is often used to describe how the profit of a corporation is taxed, and then profits distributed as dividends (which are not deductible as expenses to the business) are taxed to shareholders.

Incorporating a business involves filing Articles of Incorporation with the state, and it comes with higher startup costs and more administrative complexity than running a business as a Sole Proprietorship, Partnership, or LLC. A Corporation must have bylaws, a board of directors, hold meetings on a regular basis, and abide by other regulations to maintain its status.

When might operating as a C Corporation be preferable?

1. When a company’s profits are expected soon and will be reinvested
2. When a company wants to seek venture capital and equity financing
3. When a company wants to have a large number of shareholders

S Corporation

The S Corporation is a subtype of the corporation structure. It allows a C Corporation to elect to be taxed as a Partnership, with all business income taxed at the owner (shareholder) level at the tax rate for individuals. This avoids the double taxation that Corporations normally face (i.e., some income taxed at the corporate rate and then again taxed at the individual rate when distributed to shareholders). One potential tax advantage for owners is that instead of all their business income being subject to self-employment tax, only owners’ salaries are. Any profit given to shareholders as distributions are not.

Some other advantages of a C Corp, such as personal liability protection, are retained. On the other hand, a number of restrictions on ownership of stock apply in an S Corporation. For example, it may only issue one class of stock, it may only have up to 100 stockholders, and it cannot have shareholders who are nonresident aliens.

Today, the IRS allows multiples types of entities to elect to be tax as an S Corporation. For example, an LLC, just like a Corporation, could elect to be taxed as an S Corp if files for S Corporation Election by the required deadline.

When might operating as an S Corporation be preferable?

• When an LLC’s members want to minimize their self-employment tax burden
• When a Corporation wants to avoid double taxation on dividend income
• When a company doesn’t have a need for issuing more than one class of stock or having more than 100 shareholders

‍

Limited Liability Company (LLC)

Finally, the star of the show – the Limited Liability Company (LLC). Imagine combining the voices of Beyoncé, Rihanna, Taylor Swift, and Springsteen into one supergroup. Now imagine that group is protected from liabilities and gets to split the bill come tax season. It's the best of both worlds – you've got the benefits of corporate structure (no personal liability – yay!) and the simplicity and flexibility of a sole proprietorship. This might just be the tastiest Calzone you've ever had.

The LLC structure combines the advantages of a corporation and those of a partnership or Sole Proprietorship. It can be a single-member LLC or a multiple member LLC. Forming your business as an LLC limits member (owner) liability while requiring less paperwork and fewer formalities than a corporation. To start an LLC, Articles of Organization must be filed in the state(s) in which the business will operate and other tasks must be completed so that the company is following all applicable rules and regulations.

Taxes are handled as they are for a Partnership (or Sole Proprietorship), with all income flowing through to members and reported on their personal tax returns.

An LLC may instead elect to be taxed as a corporation by filing IRS Form 8832 (Entity Classification Election).

The LLC structure also provides management flexibility. It can be member-managed, in which owners handle the day-in-day-out management responsibilities. Or an LLC can designate a person (or persons) as a manager(s), which is called a manager-managed LLC. Most states will by default consider an LLC “member-managed” unless the formation paperwork specifies that it should be “manager-managed” LLC.

An LLC can benefit from an LLC Operating Agreement, particularly when manager-managed or when it has multiple members, to describe the authority and responsibilities assigned to the individuals involved in the business.

One disadvantage of the LLC is the inability to issue stock to raise capital. However, many LLCs are able to raise capital by issuing shares of membership, though this may be limited by the language in the LLC’s Operating Agreement.

When might operating as an LLC be preferable?

• When business owners want to limit personal liability but don’t want the compliance formalities of a Corporation
• When business owners want flexibility in who owns and manages their company
• When a business doesn’t plan to seek venture capital and equity funding

‍

The Punchline

Choosing a business structure is like choosing between pizza and sushi. It's not just about taste; it's about what works best for you. So, when selecting between sole proprietorship, partnership, corporation, or an LLC, consider the implications – financial liability, taxes, the whole karaoke playlist. But remember, just like wasabi carelessly smothered sushi can make you wince, an ill-chosen option could leave your business in a financial bind. So, weigh your choices, take a consult, and pick what works best for your business. Because at the end of the day, you don't want your business leaving a sour taste – whether it’s pizza, sushi, or Karaoke!

‍

‍

‍

‍