Choosing a Business Structure
Choosing the best business structure to operate under is one of the most important decisions you’ll make.
Choosing the wrong structure could not only make you pay unnecessary taxes but put yourself and assets (house, car, etc) at risk.
When you're ready to form your business, we recommend taking a look at our Top 7 LLC Formation Services review.
Choosing the Best Business Structure Type
You will know How to Choose a Business Structure once you've answered these questions:
- How much personal liability will you have for the business?
- How do you want your profits from the business to be taxed and handled?
- How easy is it to set up and stay compliant with the state?
- How it affects partners and the business’s ability to raise money?
With those key factors in mind, below is a list of the main four business structure types. After that, we’ll cover each business structure type in full detail to decide which one is right for you.
- Sole Proprietorship
- LLC (Limited Liability Company)
As long as you don’t have any partners, are providing a product or service to customers, and have not set up any other legal entity for your business — then you are automatically a sole proprietor.
A sole proprietorship is the simplest business structure. In fact, you don’t have to do anything to set it up. This isn't necessarily a good thing unless you operate a business with VERY little profit and very little risk.
LIABILITY OF A SOLE PROPRIETOR
There is actually no difference between your business and personal liability as a sole proprietor. You are personally liable for debt, mistakes, or anything else along those lines that are acquired by your business.
The liability will vary depending on the kind of business you are planning on opening. And it could even be something you don’t have to worry about. For instance, if you sell digital ebooks on the history of your country, you should be in the clear from liabilities.
However, if you are starting a business that transports large rocks from location to location through populated areas or roads — you might want to rethink being a Sole Proprietorship.
SOLE PROPRIETORSHIP TAXES
As a sole proprietor, you pay taxes on all earnings for your business. You pay a similar income tax rate on money from your so proprietorship as you pay if the money came from an employer.
You generally will not be able to raise money from investors or banks as a Sole Proprietorship. There will always be an exception, of course, but don’t expect it to be you. If you need to finance your business, you’ll probably want to keep reading.
GET A DBA (OPTIONAL)
If you are wanting to do business under a different name from your own, you will need to register a ‘Doing Business As’ or a ‘DBA’. So instead of operating as Steve Johnson you can ‘do business as’ SJ Consulting.
This way, when you receive checks or get paid for the service (or product) you offer, everything would be made out to SJ Consulting rather than just, Steve Johnson.
If you’d like to get a DBA, feel free to use our step-by-step guides. You can also zoom through the process (while having it done correctly) through a DBA filing service like LegalZoom for $99. All you have to do is answer questions about your business and they take care of the rest.
IS A SOLE PROPRIETORSHIP RIGHT FOR YOU?
As long as your business has a very small chance of liability, operating as a sole proprietorship might be right for you. Just make sure you keep track of your tax information and use reliable accounting software.
An LLC legally separates you and your personal assets from your business. It also provides lots of flexibility on how your business will be taxed and run.
An LLC is simple, easy to set up, very flexible, and very straightforward.
Like we said before, as an LLC, if anything were to go wrong your personal assets would be protected as long as they are not tied to your business.
LLCs are eligible for pass-through taxation, which means that the business’ profits “pass through” directly to the owners without being taxed first. Learn more about LLC Pass-Through Taxation.
IS AN LLC RIGHT FOR YOU?
The best part of an LLC is that it gives you liability protection and pass-through taxation.
LLCs also require much less paperwork and maintenance than a corporation. For these reasons and more, the LLC should generally be the first option considered when starting a business.
If you’d like to form an LLC, feel free to use our step-by-step LLC formation guide or choose your state from the list below:
- New Hampshire
- New Jersey
- New Mexico
- New York
- North Carolina
- North Dakota
- Rhode Island
- South Carolina
- South Dakota
- Washington D.C.
- West Virginia
But if you'd like to save time and have professionals handle all paperwork for you, look into a reliable LLC filing service.
The biggest advantage of a C corporation over an LLC is the ability to raise money from investors or from stock options.
But if you’re not planning on raising outside money like this, an LLC is the better option because it is far simpler to run and maintain and much more flexibility from a tax perspective.
Like the LLC, a C corporation treats the individual business owners and the business separately from a liability standpoint. So you’ll still be getting that ‘corporate veil’ that will protect your personal assets.
Note on venture capital: It’s important to keep in mind that most venture capitalists prefer investing in companies that are operating as C Corporations.
C CORPORATION TAXES
C corporation taxes are complex and require more paperwork than an LLC.
Here are a few additional things to keep in mind:
- Income from a C corporation is taxed at the current corporate tax rate (Up to 35%).
- Income that is paid out to shareholders in the form of salary is then taxed again on the recipient's personal income tax rate.
- Income that is paid out as dividends to shareholders is also tax at the current dividend rate of up to 20%.
- If the corporation meets certain restrictions it can be eligible to be treated as an S corporation from a tax standpoint in order to avoid double taxation.
C CORPORATION AND YOUR PARTNERS
Let’s assume later on that one of your partners wants to leave the business. Since C corporations are seen as separate entities from you and your partners, it can continue to operate with no harm or hassle done.
Just make sure that you have a well-crafted Partnership Agreement that outlines terms if there were ever any disagreement between any of the partners and what would be done if somebody wants out.
HAVING A BOARD AND OWNERSHIP
They have shareholders, and they have a board of directors. Let’s talk about the basic breakdown of how this works.
Your board of directors will likely decide who runs the company at the end of the day. So the more of an investment you take on, the more control you’re giving up.
And if the board doesn’t like you where you are in the company, they can replace you without a second thought. (As long as they have majority ownership of the overall business). Think of Steve Jobs getting kicked out of Apple back in 1985.
IS A C CORPORATION RIGHT FOR YOU?
Unless you’re planning to raise a large amount of money from venture capitalists or take your business public, an LLC will give you many of the same benefits with more flexibility.
You also have the option to start as an LLC and switch to a C corporation when you are ready to take on an investor or board. It will be more expensive and have more legal fees in the long run, but if you prefer to start as an LLC and switch to a C corporation, that isn’t completely uncommon. (Although it’s a lot of paperwork)
To form a C corporation, you can use an online incorporation service like IncFile (for $49) or LegalZoom (for $79) to make sure everything is taken care of. But if you’d like to handle this yourself, use our free step-by-step guides.
An S corporation is a tax designation, not a business structure.
In other words, business owners can elect to have their business treated as an S corporation from an IRS standpoint. This allows C corporations to avoid double taxation issues. (Because who wants to get taxed twice?)
Before the LLC was created, S corporations were used so that business owners could avoid double taxation. But nowadays most people choose to operate as an LLC because of its simplicity and flexibility.
S CORPORATIONS TAXES AND SHAREHOLDERS
The S corporation is simply a designation with the IRS for tax purposes so that liability is the same as it is underline LLC or C Corporation that is elected to be treated as an S Corporation.
But you will need to keep in mind that your business will have to be a domestic operation, have only allowable shareholders, and may not include partnership to qualify your LLC or your C Corporation is elect to be treated as an S Corporation.
Also, your S Corporation cannot have more than 100 shareholders and it can only have one class of stock. To be treated as an S Corporation you must setup your LLC or your C Corporation on a first and then file a form 2553 with the IRS to become an S Corporation.
IS AN S CORPORATION RIGHT FOR YOU?
If you’re operating as an LLC already then there is no reason to choose to be treated as an S corporation until the business is producing enough profit to pay yourself a substantial salary.
Which Is Best For You?
This guide was built to help you decide which is the right business structure for you. At the end of the day the choice is yours but if possible, speak with a professional.
If you already know which is the best business structure and are ready to officially form a company, here are the two best resources for getting started:
- Use our free step-by-step guides for forming an LLC or Corporation.
- Have a reliable service form a business for you. A couple of the most popular are IncFile for $49 and LegalZoom for $79.
(Note: We are not practicing attorneys and this guide is not intended to be legal advice. That said, we recommend you get personalized advice from an attorney in more detail or before you legally form your business.)