Comparing business formation types can show you the distinct advantages and responsibilities of each structure. Want to make an informed decision? Explore our guide below to determine the ideal structure for your business venture.
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After the inspiration strikes for a new start-up business, one of the first decisions you’ll need to make is choosing the business formation type (or business structure or entity type) you’ll use for your new company. The type of business structure you should choose depends on how you want to run your business, how you want to be taxed, and how much personal liability you’re willing to expose yourself to.
Every type of structure has pros and cons associated with it, so it’s important to understand your options so you can choose the one that best fits your needs and your vision. Once you choose the structure that fits, you can incorporate it into your business plan.
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A limited liability company, commonly called an LLC, is a popular business structure because it combines the benefits of multiple business types into one. LLCs have the tax advantages of a sole proprietorship or general partnership while also providing the personal liability protection of a corporation. For a more detailed answer, see our LLC definition page.
An LLC is a separate legal entity, meaning that it and the owners (who are called “members” in an LLC) are not the same in the eyes of the law. If the LLC is sued or goes into debt, the members’ personal assets (savings, home, cars, etc.) are usually not at risk.
As with a corporation, forming an LLC does require you to pay a fee and file paperwork with the state, but the management of an LLC allows for much more flexibility than a corporation with less paperwork and fewer reporting requirements. LLC members can draft an LLC operating agreement to customize the rules for managing the company.
LLCs also have tax advantages. By default, LLCs are taxed like sole proprietorships or general partnerships. This usually means that profits are not taxed at the business level before being distributed to the members, who only pay income tax from their share of the LLC’s profits on their personal tax returns. More than 90% of our customers choose to form LLCs when they purchase one of our business formation plans.
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This more complex structure can issue shares or take the business public.
The default form of corporation is a C corporation. Like an LLC, a corporation is a separate legal entity from its owners, who are called shareholders. The corporate structure shields the shareholders’ personal assets from the liability and debts of the business.
One disadvantage for C corporations is what’s known as “double taxation.” When a C corporation makes a profit, that income is taxed at the corporate level. Then, when the profits are distributed to the shareholders, they’re taxed again, this time on the shareholders’ personal tax returns.
The structure of a corporation is also more rigid. Shareholders must elect a board of directors to oversee the management of the business. In turn, the board of directors must ensure that the decisions made benefit the corporation and the vision of the shareholders. Corporations also have more complex reporting requirements and other paperwork. Decision-making can also be a slower process due to the numerous people involved with a board of directors.
Because ownership in a corporation is divided into shares, transferring ownership is actually easier than it is for other business structures, such as an LLC or partnership.
As with LLCs, we can help you navigate the corporation formation process with our business formation plans.
This tax designation could reduce taxes for certain LLCs and corporations.
An S corporation is not really a separate kind of business structure, but a tax election status. A C corporation or an LLC can apply for S corporation status with the IRS. S corporation status is often a way for C corporations to avoid double taxation because they’re taxed like a general partnership or sole proprietorship.
One reason an LLC might opt for S corporation status is that it can save the owners money on self-employment taxes by splitting income into two groups, salary and distribution. The IRS only requires you to pay the 15.3% self-employment on your salary and take the remainder as a distribution not subject to self-employment tax.
S corporations do have some restrictions, though. An LLC or C corporation can file to become an S corporation only if they meet the following conditions:
The small business taxes around S corporations can get complicated, so it’s wise to consult a qualified tax professional for guidance or use our S corporation filing service.
A sole proprietorship may be the simplest type of business you can create; you’re not required to file any paperwork with the state to be a sole proprietor. With a sole proprietorship, a single person writes the business plan and then forms, owns, manages, and controls the business. This means that all profits come directly to you, but you’re also responsible for all losses.
Advantages of a sole proprietorship include easy management, simple decision-making, and flexibility. Disadvantages include unlimited liability if the business is sued or has financial problems.
A general partnership is a company that is owned by two or more people. With this type of business structure, the partners all contribute funds to start the company, and everyone is responsible for its management. Sometimes, partners work out a partnership agreement where each person assumes specific roles within the company.
General partnerships are easy to start; they usually require no paperwork to be filed with the state. They often require less capital because multiple people contribute to the start-up costs. As with sole proprietorships, general partnerships involve unlimited liability for business debts. Sometimes, partnerships also run into trouble if partners don’t work together effectively. Learn how to form a general partnership.
A nonprofit corporation is an entity formed to benefit the public in some way. Private and community foundations can both fall under the nonprofit umbrella. Nonprofit corporations can be exempt from federal income tax, but only if they successfully apply for 501(c)(3) status with the IRS.
The tax-exempt status of nonprofit corporations is a distinct advantage of this type of business structure, and the founders and directors of nonprofit corporations also enjoy limited liability for business debts. Drawbacks include the large amount of paperwork necessary to launch and operate a nonprofit as well as high costs and ongoing public scrutiny regarding finances and expenditures.
The right business structure depends on your specific needs, circumstances, and plans for your business. Here are some considerations to guide your decision:
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Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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