Choosing the legal structure of your business impacts the personal liability the owner may face, the amount of taxes to be paid, the amount of control the founder has over decisions and more. The type of entity that you choose will be based entirely on your individual circumstances. Here are the advantages and disadvantages of common business structures.
This is the most simple and common form of business. There is no distinction between the business and the owner.
- Owner has complete control over the business and all decisions.
- It is a simple and inexpensive entity to form, paperwork-wise.
- There are few legal requirements in terms of record keeping
- The owner has unlimited liability.
- With only one owner, all burden is imposed on one person.
- The business is not taxed separately so the owner is responsible for all taxes.
- Raising money is difficult because investors aren’t buying stock in the business.
A single business in which two people share ownership. Each partner contributes to all aspects of the business and share in profits and losses.
- Shared ownership allows for disbursement of responsibilities based on strengths or interests.
- Relatively simple to form with few legal requirements.
- Business losses can be deducted from taxes.
- Sharing financial resources allows partnerships more access to capital.
- Partners have joint and individual unlimited liability.
- Profits are shared between partners and each partner pays taxes on income and profit earned from business.
- Disagreements are likely amongst partners.
Limited Liability Company
A Limited Liability Company (LLC) is a combination of the limited liability benefits of a corporation and the simplicity and flexibility of a partnership.
- Member agreement can be written in whatever way suits the members of the company.
- Members are protected from personal liability of business decisions or actions.
- Profits are shared amongst members as they see fit so there is an opportunity for members to participate in the growth of the business in a variety of ways and still see profits.
- Forming the company requires more steps and paperwork than a sole proprietorship or a partnership.
- The LLC’s life is based on the participation of members. If one member leaves, the rest of the membership can choose to stop their business relationship or start a new LLC.
- Members of an LLC are considered self-employed and taxed accordingly.
A corporation is a more complicated structure than those described above. It is a legal entity owned by shareholders which has complicated legal requirements, taxes, and administrative fees involved.
- Owners of a corporation only pay taxes on profits paid to them through salary, dividends or bonuses. Additional profits are taxed at a lower, corporate rate. The corporation pays taxes separately.
- The corporation is responsible for all debts and shareholders personal assets are protected.
- Generating capital is simplified when using a corporation through the sale of stock.
- It can be difficult, expensive and time-consuming to start a corporation.
- Corporations are sometimes taxed twice - when the company makes a profits and when dividends are distributed.
- Paperwork is complicated due to regulations through federal, state, and local agencies.
An S Corp is similar to a C Corp, but you are taxed only at an individual level.
- Tax savings are on of the biggest advantages of starting an S Corp. Only S Corp shareholders who are also employees are taxed at the employment rate.
- The S Corp is independent from shareholders and continues doing business regardless of the movement and changes of shareholders.
- Business expenses can be written off and for shareholders/employees who own more than 2% of the company, health and life insurance are taxable income.
- Shareholders must receive reasonable compensation and the S Corp may be reclassified if the IRS notices discrepancies in compensation (between salary and distribution).
- The operational process of the S Corp require that shareholder and directors meetings are held, meeting minutes are kept, by-laws are adopted and updated, and that records are maintained well.
Choosing the right structure for your individual needs will ensure your company starts off on the right foot. We recommend checking with a business attorney if you are choosing any of the more complex structures.