Business Structures – Different Types and What to Know About Them
This guide will help you understand what business structures are available, what they each mean, and which may be the best for your business.
One of the first decisions a small business owner will make is what organizational structure to register their business under. While this may seem like a formality for government paperwork, each type of structure comes with many implications, from tax rates to liability implications.
Understanding how each business structure works and what it could mean for your business is critical before you register with the state.
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What’s a business structure?
A business structure refers to the type of legal entity your business is registered with the government under. The form of business you choose will determine the type of income taxes you file, personal liability, and other reporting and licensure requirements that may come up.
The available business structures are:
- Limited Liability Company (LLC)
- Sole Proprietorship
- Partnership
- Corporation
You may also hear about S Corps, B Corps, and Non-profits when referring to business structures, though they are not actual options for registering with the government.
How do you figure out which business structure is best for you?
When selecting a business structure, there are a number of things to consider. The question of whether you will be the only owner or work in partnership with others will automatically eliminate certain options. From there, you should consider the legal liability and tax structure to determine what makes the most sense for you from a personal and business perspective.
You may also want to consider the costs associated with each structure and other reporting requirements to ensure you can meet all obligations. While you can switch structures down the line, keep in mind the flexibility you may need and what the ultimate goals you have for your business may be.
Once you have considered these factors, you can check your state’s website to ensure you meet any additional requirements and have chosen the right structure for your business.
What are the different types of business structures?
Each form of business has unique elements and use cases where it will be the best option for a business. There are also varying processes for forming and maintaining each type of business.
LLC
What is it?
An LLC, or limited liability company, is an organizational structure that incorporates elements of corporations, general partnerships, and sole proprietorship. The owner of an LLC is generally known as a member and has protection from liability and other obligations, like debts and lawsuits, similar to those offered to a corporation.
An LLC can have one or multiple owners who are offered this protection. However, the protection is not as extensive as some industries require, so things like banks and insurance companies cannot file as an LLC.
Who is it best for?
Those looking to start a business who do not want to take on personal risk often choose an LLC. The maintenance of an LLC is less intensive than something like a corporation with less complexities, but there is still protection from liability.
How is it formed?
In order to form an LLC, you must register the business with the state where you will operate. This involves ensuring your business name is unique, assigning a registered agent, and providing basic information to the issuing department.
Sole Proprietorship
What is it?
Sole proprietorship is the simplest business structure available. In these entities, a single owner has complete control of the business and operates as a single unit for the purposes of tax and liabilities. There is no liability protection for a sole proprietor and profits and losses made by the entrepreneur are included as a part of their personal income taxes.
Who is it best for?
Those looking to quickly start a new business without a lot of paperwork may choose a sole proprietorship. Anyone comfortable taking on the additional risk of their business or who does not feel they need protection may also choose this structure.
How is it formed?
There is no formal process to register or form a sole proprietorship. Simply operating a business on your own qualifies you as a sole prop. However, many people choose to operate the business under a name other than their own, which can require filing a DBA or fictitious name form with the state.
Partnership
What is it?
A partnership is formed when two or more people join together to run a business, with each person having an equal share in profits and losses. Each partner will report their income from the business as a part of their personal tax return and take on personal liability for debts and obligations of the company.
Who is it best for?
Partnerships are simple to start and maintain, with less formalities than other business organizations. Those who want a quick and easy start to their business may opt for a partnership. Because it does not require formal agreements, people who want to go into business without binding themselves to an agreement may also prefer this structure.
How is it formed?
General partners must be registered with the state, usually through the Secretary of State or another issuing agency. While it is not required to provide a partnership agreement, it can be wise to have all terms decided upon prior to this registration.
Corporation
What is it?
The most complex business structure is a corporation. It’s a legal entity entirely separate and independent from the people who own and run the corporation, including shareholders. The corporation can enter contracts independently of these individuals and has separate financial obligations, including taxes. Ownership of a corporation is determined by issuing shares of stock.
Who is it best for?
Corporations are generally best for larger, established companies with multiple employees. Some smaller organizations will choose to be incorporated because their industry exposes them to sizable liability, but this is rare.
Corporations face double taxation, which means the company pays a corporate tax and anyone who receives income from the company is also taxed.
How is it formed?
Like other structures, a corporation must be registered through the state via Articles of Incorporation. This process also requires the preparation of corporate bylaws and the creation of set operations of the business. A corporation must hold regular board meetings, issue stock, provide decision-making information to stockholders, and file annual registrations. Corporations are subject to taxes and regulations other structures may not be.
S Corp
What is it?
An S corp is not a business structure. Instead, it’s a tax classification.
Rather than the corporation being treated as a separate tax-paying entity, an s-corp passes income, losses, deductions, and credits through to its shareholders for federal tax purposes.
Who is it best for?
Doing business as an S corp offers more flexibility in terms of how a business is run without all the formalities a corporation requires. These businesses must have under 100 shareholders and can only issue one class of stock. They are also required to be a domestic business entity and all shareholders must be citizens or legal residents of the United States.
How is it formed?
Again, an S corp is not a formal business structure, but instead a tax designation. You can create an S corp by setting up an LLC or corporation and choosing the S corp status on the IRS forms needed to employ for an EIN.
B Corp
What is it?
A B corp is a voluntary designation that companies choose, not a formal business structure. These companies voluntarily agree to meet high standards for social and environmental performance and complete a rigorous certification process. The goal of this certification is to show that the company does not only prioritize profit, but also other issues.
Who is it best for?
Any company can choose to become a B corp if they are committed to social and environmental standards and are willing to meet the guidelines.
How is it formed?
B Lab, the nonprofit behind the concept of a B Corp, issues an assessment of the company’s impact on all stockholders. If all the criteria are met, the company can be called a B Corp. This would not replace any traditional formation steps for other company structures.
Nonprofit
What is it?
A nonprofit is a type of business that is tax-exempt under the United States tax code because it does not derive a profit that is passed on to shareholders. These are generally charitable or community-focused groups. There are nonprofit corporations, but they can also be a foundation or community chest fund.
Who is it best for?
This structure will be best for those who are not interested in growing profits or having stocks issued and are focused on a charitable cause.
How is it formed?
A nonprofit can be incorporated by the state via Articles of Incorporation and naming a registered agent, much like a corporation. The designation of nonprofit will be assigned by the IRS if qualifications are met.
FAQs
Who can help you select the best type of business to set up?
If you are unsure of the right business structure for you, a business attorney or a tax professional would be good places to begin asking for advice. They can help you understand the legal and financial implications of each choice and determine the right fit for your business.
Are business structures tied to taxes?
Yes, which business structure you choose will directly impact how taxes are filed. Some structures will not have separate taxes from the owner, while others will be filed independently. Some structures, like corporations, may also see different rates than individual taxes.
What’s the cheapest and fastest business to set up?
A sole proprietorship is a fast and cheap option, as it requires no registration and no fees. You will have to register and pay if you want to use a fictitious name, but otherwise, you can start a sole proprietorship at no cost.
Which type of business offers the best personal liability protection?
Corporations are legally liable as separate entities with no tie to the person who set up the business. The cost to form a corporation is higher and they are more highly regulated because of the protection offered. An LLC does offer some liability protection as well, but it’s not as strong as a corporation.
What’s the difference between an LLC and a sole proprietorship?
The primary difference has to do with the liability offered by the business structure.
A sole proprietorship is treated as one entity as a tax treatment. The owner will file their personal income taxes and reflect the business’ financials in that filing. Because they are the same entity, the owner also assumes any and all liability for debts, obligations, and lawsuits on behalf of the business.
An LLC is a separate legal entity that offers some protection from these liabilities, allowing the startup to be treated as a separate entity for tax and other purposes. If an LLC gets into financial trouble or gets sued, the owner’s personal assets are protected since they are separate from the business.
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