Choosing the Right Business Structure
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Every business is unique—focusing on different industries, offering different services with different goals and company sizes. Among so much variety, there is one constant: every business must pay taxes.
Several variables impact how a business pays taxes. One of the most significant factors is the way your business is structured. It goes beyond taxes; whether you’re getting a startup off the ground or ready for your business to go public, how the company is structured affects everything.
Here is a breakdown of some of the pros and cons of the main types of business structures:
Sole Proprietorships
Sole proprietorships are the simplest form of business entity. This type of business structure is usually straightforward to set up and gives you, as the business owner, complete control. However, with that control comes liability. There is no legal separation between the owner and the business. In sole proprietorships, the owner is also held personally liable if the company is sued, owes a debt, and more.
Pros
Simple & easy to set up
Cons
No legal separation between sole proprietor and business
Partnerships
Partnerships are businesses that are both owned and operated by multiple individuals. One of the most significant benefits of structuring your business as a partnership is that they are considered pass-through entities, meaning the company does not pay income tax; instead, the tax burden is passed through to each partner individually. All profits and losses are reported on the partners’ individual income tax returns.
Pros
Business does not have to pay income tax
Cons
All tax liability falls on partners as individuals
LLCs
Limited Liability Companies have become an increasingly popular business structure in recent years. This business structure brings together the best features of partnerships and corporations.
Similar to a partnership, LLCs are pass-through entities, meaning the business does not have to pay income tax; it passes through to the owners’ personal tax returns. However, LLCs were created to give business owners the same liability protection as a corporation.
While LLCs provide a range of benefits, they are typically more challenging to form and maintain than sole proprietorships. It can also be difficult to transfer ownership of an LLC.
Pros
Business does not have to pay income tax
Considered its own legal entity separate from owners
Cons
More expensive to establish and maintain than sole proprietorships
Difficult to transfer ownership
C Corps
Corporations are independent legal entities separate from their owners. A C Corporation is what is known as a standard or default corporation by the IRS. These business entities offer limited liability protection to owners. They are taxed at the corporate level rather than passing through to the owners. In addition to corporate taxes, if a C corporation has shareholders, they are also taxed. (There are no limits on the number of shareholders a C Corp may have.)
Pros
Unlimited shareholders
Considered its own legal entity separate from owners
Cons
Double taxation for owners that are shareholders
S Corps
An S Corp is another type of corporation, so they are considered independent legal entities meaning owners aren’t liable for the business’s profits and losses. However, unlike C Corporations, S Corps are pass-through entities.
While S corporations have more tax flexibility, they are held to different standards than C Corps regarding ownership and shareholders. S Corporations are only allowed to have 100 shareholders or less. Also, they cannot be owned by another corporation of any kind or an LLC.
Pros
No corporate-level taxes
Pass through of losses
Cons
Shareholders limited to 100 maximum
Ownership limitations
Choosing a Business Structure
How you structure your business is one of the most important decisions you’ll make as a business owner. Things like thorough tax planning and goal analysis will help determine which kind of business structure is best for you and your business.
Have questions about business structures or what might be best for your business? Our business advisory and tax planning experts are here to help. Contact Us.