A business structure describes the legal entity of a business, which is how the law will see the person(s) or company that owns and operates it. Ownership is typically determined by shares pertaining to voting rights, stock dividends, profits, etc., depending on the type of company.
Factors such as profitability, corporation type, and size will be considered when choosing a structure for a business.
The most basic form of commercial enterprise is known as “sole proprietorship”, which refers to one person working without any other owners. If there are two or more people involved, this would be called a partnership.
A corporation is formed when an organization creates its legal entity through a state filing. The last type of commercial enterprise, the limited liability company (LLC), offers members protection from corporate debts. Here’s a closer look at each type:
What Is A Sole Proprietorship?
A sole proprietorship is the simplest commercial enterprise structure. It’s also known as a “sole trader” if you’re located in some parts of the world. This business model exists when one person owns and operates an independent company that isn’t divided into shares or stock, meaning there are no other owners.
Any profits or losses are also calculated on personal tax returns. While this arrangement requires more recordkeeping than others (like partnerships), it’s easier to start up and doesn’t require any formal legal filings with your state.
A sole proprietorship does not pay income taxes like a corporation; they are filed through your individual tax return at the end of each year. A sole proprietorship is very easy to form.
All you need to do is file a DBA with your state government to create a legal business name. There are other requirements, depending on which state you live in, but this is an example of the simplest entry requirement.
You also need to get a federal Employer Identification Number (EIN), which can be applied for online through the IRS website. This number will be referenced on official filings and correspondence with other agencies.
Sole proprietor’s don’t have shareholders to report their results or capital gains; instead these returns are reported on Schedule C of your 1040 tax return at the end of each year.
What Is A Partnership?
A partnership is another simple business structure that requires little formality beyond agreements between partners (and maybe some minimal corporate filings).
A partnership provides personal liability protection to the owners, meaning they aren’t held accountable for business debts or other obligations.
However, this type of arrangement does require more formalities, including filing a DBA statement with your state and drafting an operating agreement that details each partner’s role in management.
Partnerships are taxed as “pass through entities,” which means income and losses pass through to individual partners’ personal tax returns. There is no separate taxation, and all partners report their share of the profits (or losses) on Schedule E of their 1040s at the end of each fiscal year.
The most common mistake made by new partners is not having a written partnership agreement; if you don’t have one it will be difficult to enforce any expectations among your business associates.
What Is A Corporation?
A corporation is a specific type of legal entity that’s created through a state filing. It requires more formalities to start compared to sole proprietorships or partnerships, including the drafting and implementation of articles of incorporation.
These articles define a business’ purpose and other essentials meant to keep it in line with local rules and regulations. Corporations also have their own tax structure, meaning they are taxed separately from their shareholders for any profits earned.
In order to avoid double taxation, members may choose to be taxed as an S-corp or C-Corp. The difference between these two types depends on the company’s goals and needs.
An S-Corp must have only one class of stock, which means they can’t have different types of shares with different voting rights. An S-Corp must also file as a corporation with the IRS and have fewer than 100 shareholders.
C-Corps require more formalities before being approved for operation. These companies need to have specific rules enforced in their articles of incorporation and other filings and cannot be created if they violate any regulations outlined by the state where they are established.
There is no limit on the number of shareholders a C-Corp may have, but there is a limit on the type of investors. As a company gets larger, it must transition from registering shares in-house to using a transfer agent and depository. This ensures all shareholders are registered properly and complies with SEC regulations.
What Is A Limited Liability Company?
A limited liability company (LLC) is a business structure that gives its owners and members protection from personal liability. Like a sole proprietorship or partnership, an LLC acts as a pass-through tax entity.
In other words, it does not pay taxes on the income as the entity; instead, profits and losses are “passed through” to each individual’s personal tax returns.
Some states also allow for S corporation treatment of an LLC, which allows it to avoid double taxation at both the corporate and owner levels.
More About Limited Liability Company Structures
A Limited Liability Partnership (LLP) is a business structure that gives its owners and members protection from personal liability, much like an LLC does; however, a limited liability partnership (LLP) has one key distinction in that it must have at least one general partner .
A general partner has unlimited personal liability for the LLP’s debts and obligations. This distinction between members and partners and their respective rights and responsibilities can be important in certain circumstances.
The LLP distinction also governs management and operational decision making and affects how profits and losses are allocated among owners. Owners of an LLP are sometimes referred to as “members”, but this term is not used consistently across all states. Some states refer to LLPs as limited partnerships or “LP”.
Some things to consider when deciding for file for an LLP or LP may include:
- The number and types of partners involved in the venture, and whether those partners will stay throughout the duration of the business’ growth
- The amount of control an individual wants to exert over the day-to-day aspects of running a business
- Whether or not that person is willing to sacrifice their personal assets if something goes wrong as a result of their decisions as a business owner
Do I Need a Lawyer for Help Choosing a Business Structure?
Consulting with a corporate lawyer can be a good idea since there are many different kinds of business structures. Deciding what kind of structure would be best for your needs can be overwhelming, but as any entrepreneur knows, having the right type of organizational structure for their new company or business venture is important.
Making the wrong business structure choice can lead to unpleasant surprises and unnecessary expenses down the road as you attempt to build up your business and continue its growth.
It’s also a good idea to have an attorney familiar with business organizations available to represent you in the event that a dispute arises.
Contacting a legal advisor who specializes in helping people build up new businesses could be your next step.