How should you structure your business? (2024)

Which form of organization (sometimes referred to as 'business entity") will be best for your business? Two key features to consider in structuring your business are liability protection and desired tax treatment. You should discuss the best business entity for your situation with an attorney who will describe the legal ramifications and assist you with the filings and an accountant who can provide you with tax advice on the different types of business entities.

There are several ways to form a business including sole proprietorship, partnerships, corporations, limited liability companies, and limited liability partnerships. When choosing a business entity to consider liability protection, taxes, management structure, ownership transition, and capitalization.

Sole Proprietors

The sole proprietorship is a popular and frequently used form of business organization. It is an unincorporated business owned by a single individual. When your business is organized as a sole proprietorship, your personal and business affairs are merged together. As the proprietor, you own and control the business. From the standpoint of nearly all legal rights and responsibilities, your sole proprietorship business and you, as the owner or proprietor, are considered to be one and the same.

Pros

  • Inexpensive to start
  • Simple to run
  • No double taxation on profits

Cons

  • The owner has unlimited personal liability and/or business liabilities
  • The business has unlimited liability for the owner's personal liabilities.
  • Ownership is limited to one person.

Partnerships

A partnership combines one or more individuals or businesses as co-owners under a partnership agreement. The agreement should be in writing and determine the powers, liabilities, and authorities of each partner. The lack of a written agreement can result in extremely damaging conflicts between partners when a disagreement arises. There are two forms of partnership: The General Partnership and the Limited Partnership.

General Partnerships – In this type of agreement, the income and expenses of the partnership are directly taxable to each individual general partner based on his/her proportionate interest in the firm. The partnership files an information tax return and pays no separate business income tax. Even a well-crafted partnership cannot completely protect against a partner acting outside the scope of the agreement and incurring debts and liabilities that become the responsibilities of the other partners.

Limited Partnerships – In a limited partnership, "limited" partners have protection against obligations of the firm beyond their initial investment, as with a corporation. Limited partnerships must have at least one general partner responsible for all the debts, liabilities and obligations of the firm. A limited partner should not take an active role in the business and risks becoming a general partner by doing so. In a limited partnership, most partners limit their liability while keeping their rights to participate in profits and/or tax advantages.

Pros

  • A flexible form of business
  • Permits ownership by more than one individual
  • Avoids double taxation.
  • Few legal formalities for its maintenance

Cons

  • General partners have unlimited personal liability for business losses.
  • The partnership is legally responsible for the business acts of each general partner.
  • General partnership interest may not be sold or transferred without the consent of all partners unless otherwise agreed.
  • Partnership dissolves upon the death of a general partner

Corporations

A corporation is a separate legal entity, distinct from its owners with rights, duties, powers, and responsibilities in and of itself. The corporation may enter into contracts, own personal property, and real estate, and sue and be sued. As a result, the stockholders of a corporation assume no personal liability for the debts of the business. The risk is limited to the amount of the investment the owners make in the firm. The limitation on personal liability is one of the chief benefits of forming a corporation. A stockholder may sell his or her interest in the company without first obtaining the approval of other stockholders unless they agreed otherwise. A corporation can continue to exist indefinitely regardless of whether investors or owners quite, die, or declare bankruptcy.

On the special type of corporation of interest to small businesses is the Subchapter S corporation. This type of corporation avoids double taxation by having its income taxed to the shareholders as if the corporation were a partnership. It also allows the shareholders to have the benefit of offsetting business losses incurred by the corporation against the income of shareholders. However, you must contact the Internal Revenue Service (IRS) office to have the corporation specifically recognized as a sub "S" corporation.

Pros

  • Provides limited liability to owners
  • Easy to transfer ownership.
  • Easy to add additional owners/investors

Cons

  • More costly to set up and maintain.
  • Requires separate tax returns.
  • Subject to double taxation

Limited Liability Companies (LLC)

An LLC combines many of the advantages of a corporation with many advantages of a partnership. Like a corporation, An LLC is a separate and distinct legal entity. LLCs can obtain a tax identification number, open a bank account, and do business, all under its own name. Like a partnership, there is no double taxation and more tax flexibility than a partnership. A primary advantage of an LLC is that its "members" (owners) are not personally liable for the debts and liabilities of the LLC. If the assets of the LLC are not enough to cover the debts and liabilities, the creditors generally cannot look to the members, managers, or officers for recovery. Having a formal written operating agreement lends credibility to your LLCs separate existence.

Pros

  • Recognized as a separate legal entity from its members
  • Shields members from individual liability
  • Avoids double taxation of profits.

Cons

  • More costly to set up and maintain than a general partnership or sole proprietorship.
  • More paperwork and documentation.

Limited Liability Partnerships (LLP)

The LLP is a type of general partnership offering certain unique advantages. An LLP can be formed so that all partners can participate in the management process. Income is not taxed to the LLP, but is instead "passed-through" and taxed to the partners at their individual tax rates, much like a general partnership is taxed. LLPs offer broader financial protection for partners by setting rational limits to the exposure of out-of-pocket expenses and insulating the personal assets of one partner from other partners' misconduct. Other than a one-time filing of a registration statement no other annual filings are required.

Nonprofits

A nonprofit corporation forms for purposes other than generating a profit and in which no part of the organization's income is distributed to its directors or officers. A nonprofit corporation can be a church or church association, school, charity, medical provider, legal aid society, volunteer services organization, professional association, research institute, museum, or in some cases a sports association. Nonprofit corporations must apply for tax-exempt status at both the federal and state level.

How should you structure  your business? (2024)

FAQs

What is the best way to structure a business? ›

Review common business structures
  1. Sole proprietorship. A sole proprietorship is easy to form and gives you complete control of your business. ...
  2. Partnership. Partnerships are the simplest structure for two or more people to own a business together. ...
  3. Limited liability company (LLC) ...
  4. Corporation. ...
  5. Cooperative.
Jan 5, 2024

What are the 4 types of business structures? ›

The most common forms of business are the sole proprietorship, partnership, corporation, and S corporation. A limited liability company (LLC) is a business structure allowed by state statute. Legal and tax considerations enter into selecting a business structure.

How do you determine the best structure the fits your business? ›

To choose the best business structure for your company, consider the nature of your business and the number of owners, the personal involvement, and the level of control you want to maintain. Your choice will also depend on the amount of liability protection you need and the amount of profit you anticipate making.

What is the best organizational structure for a small business? ›

The functional reporting structure is one of the most common types of org structures. It groups employees together based on their function, or role, within the organization. For instance, the sales team works in one department, the IT team in another and the finance team works in a third group.

What is the most common way to structure a business? ›

A sole proprietorship is informal and easily created, which is why it is the most common structure chosen by new businesses.

What is the most popular business structure? ›

The sole proprietorship is the most common form of business organization.

Which business type is best for tax purposes? ›

Limited Liability Company (LLCs)

LLCs are generally the preferred entity structure for certain professionals and landlords. LLCs have flexibility as the owners can file as a partnership, S Corporation or even sole proprietor since the LLC is really a legal and not tax designation.

What are the three main structures of a business? ›

There are three common types of businesses—sole proprietorship, partnership, and corporation—and each comes with its own set of advantages and disadvantages. Here's a rundown of what you need to know about each one. In a sole proprietorship, you're the sole owner of the business.

What form accounts most sales? ›

1. The correct answer is a. Corporation.

What should a company structure look like? ›

The pyramid-shaped organizational chart we referred to earlier is known as a hierarchical org chart. It's the most common type of organizational structure—the chain of command goes from the top (e.g., the CEO or manager) down (e.g., entry-level and lower-level employees), and each employee has a supervisor.

Should I choose sole proprietor or LLC? ›

An LLC has distinct advantages in the areas of legal protection and liability. While there are filing fees for setting up an LLC, that cost can be well worth it when compared to the thousands of dollars you could be liable for as a sole proprietor. On the other hand, it costs no money to start a sole proprietorship.

What is a business structure example? ›

Sole proprietorship

In a sole proprietorship structure, one person owns the business and runs its operations. It's one of the most common business structures because it's often the simplest to set up. If you plan to work alone, this may be the right structure for you.

Which business structure is the easiest to start? ›

Easy to Form – Sole Proprietorships are the easiest, most common, and least expensive business structure. A person is essentially a walking, talking sole proprietorship in waiting. All you need to do is sell something—a product, a service, anything—and boom … suddenly you're a sole proprietor.

What is the simplest organizational structure? ›

Flat Organizational Structure

There are fewer middle managers between employees and top-level managers. This type of structure requires less supervision and requires more employee involvement. Flat organizational structures are very simple and sometimes might be referred to as a flatarchy.

What are the 3 main types of business structures? ›

Types of Business Structures
  • Sole proprietorship. The most common business structure type is a sole proprietorship. ...
  • Partnerships. A partnership is a business that two or more individuals own and operate together. ...
  • Corporation. A corporation, or C Corp, is separate from its owners. ...
  • S corporation. ...
  • Limited liability company.
Feb 6, 2024

What is better for a small business, LLC or corporation? ›

You might choose an LLC if you want to avoid corporate taxation, don't plan to fundraise with investors and prefer minimal formal regulations. You might choose a corporation, on the other hand, if you're looking to sell ownership, attract investors or go public in the future.

How to structure a business with two owners? ›

A partnership is a single business where two or more people share ownership. In this situation, it's important to create a partnership agreement. Each person contributes money, property, or labor and expects to share in business profits and losses.

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