Posted by Shivali Anand
March 14, 2022 | 5-minute read (860 words)
You may have started your business in a humble garage, warehouse or dorm room. But now your goal is to grow it from a side project into a profitable business.
Part of the process will entail choosing how to structure your new venture. Whether you choose a sole proprietorship, a C-corp, an S-corp, an LLC or an LLP, each will have its own pros and cons.
Your selection will affect management authority, taxes, personal liability and operational costs. To help you make an informed decision, below is an overview of business structures.
Sole proprietorship
Anyone who conducts business without forming a separate legal structure is considered a sole proprietor. With a sole proprietorship, you retain complete control over the business, but this structure does not distinguish among your personal and company assets and obligations. What this means is you could face personal liability for your company's debts.
Some sole proprietors experience difficulty obtaining business financing and struggle to sell their equity.
Partnership
If you are planning to partner with one or more people, you may consider forming a limited partnership or a limited liability partnership. Partnerships are popular among firms with several owners, professional organizations such as attorneys and accountants, and groups seeking to trial their business idea.
With a limited partnership, there has to be at least one general partner who makes business decisions and who is personally liable for business debts, and at least one limited partner. With limited liability partnerships, there are no general partners. All owners of an LLP have limited personal liability for business debts, and all partners are allowed to be involved in the management of the LLP.
With partnerships, the partners themselves are taxed on their personal income tax returns for their share of ownership in the partnership.
Limited liability company
As the business owner of an LLC, you are considered self-employed and are responsible for self-employment tax and for paying Social Security and Medicare taxes equal to what is collected from the business and any employees. All of the LLC’s profits and losses “pass through" the business to the LLC owners, who must report this information on their personal tax returns.
According to the Small Business Administration, LLCs are a wise choice for medium- and high-risk enterprises, entrepreneurs with considerable personal assets to protect and entrepreneurs looking to pay a lower tax rate than they would with a corporation.
C-corporation
A C-corp is any corporation that is taxed separately from its owners. The structure of a C-corp is frequently more costly, as many fees are incurred in filing the articles of incorporation. Also, corporations pay fees to the state in which they operate.
If you decide to form a C-corp, prepare for recordkeeping and financial reporting requirements. The C-corp’s owners and shareholders are protected from liability. However, you’ll have to pay income taxes on the company's earnings, as well as taxes on dividends given to shareholders, although you can make money by selling stock. You can generally continue doing business as usual when an owner departs the C-corp.
The C-corp may be the best choice for a business that will seek investment from venture or angel investors. It also may be the right choice for businesses that plan to grow large enough to have an IPO or acquisition. This is because of the lack of restrictions on ownership and share classes.
S-corporation
In contrast to a C-corp, an S-corp allows its owners to avoid double taxation. Profits and losses can be carried over to the owners' personal income without incurring corporate tax rates.
The S-corp cannot have more than 100 owners, and all stockholders must be U.S. citizens. The firm continues to function regularly even if a shareholder sells their shares or quits.
According to the U.S. Small Business Administration, an S-corp can be a good option for a business that would otherwise be a C-corp, but that meets the criteria to file as an S corp.
B-corporation
The B-corp, also known as a benefit corporation, is taxed similarly to a C-corp but driven by profit and mission rather than profit alone. A B-corp is supposed to create a public benefit in addition to earnings, and some states require these businesses to publish annual benefit reports.
If this legal status is available in your state, you might not need to pay a third-party certifying agency to register as a B-corp. However, such businesses might be able to help you with the paperwork.
Nonprofit
This structure might be ideal if your firm was created to operate for a collective public or social benefit. Nonprofits may be tax-exempt, but they must petition for this exemption with the IRS separately from state registration.
Nonprofits are restricted in terms of what they can do with their profits, which means they can't share them with their customers. The IRS code for nonprofits is 501(c)(3).
Cooperative
Cooperatives are businesses run by their member-owners. While members can buy shares, they all have equal voting power. Profits and revenues are divided among members, which is a cooperative's most distinguishing attribute. Board members are elected to run the cooperative on behalf of its members.
