The IRS recognizes 5 types of business structures: Sole Proprietorship, Partnership, Corporation, S Corporation, and Limited Liability Company (LLC). As a business plan writer, I have been asked time and again what business structure would be best. The answer is dependent upon goals, funding, and if you want to separate your personal assets from your business should the unexpected happen (and you should!).
I almost never recommend sole proprietorship for the purpose of protecting your personal assets should something unexpected happen. This could run anywhere from a lawsuit to business bankruptcy to taxes. This structure is usually the easiest to set up, but it can be really hard to get funding as most banks hesitate to lend to this structure. This is best for a low-risk business or to test a market.
A Partnership is exactly that, a partnership between two or more people to own a business. There are Limited Partnerships (LP) and Limited Liability Partnerships (LLP). Limited Partnerships have one member with unlimited liability and the remainder have limited liability and control. LLPs provide limited liability to all members, protecting all from debts against the partnership and the actions of other members.
A Limited Liability Company (LLC) gives protection of personal assets in case of bankruptcy or lawsuits. It is fairly simple to setup as most states have simplified the filing processes online and most filing fees are reasonable. I say most because Illinois used to have an exorbitant fee for LLC filing. The taxes are typically not as hefty as a corporation. This is my personal favorite structure as a small business owner or entrepreneur for the protections, tax purposes, and ease of annual filing processes.
A Corporation (also called C Corp), is a legal entity of its own. Corporations can make a profit, be taxed, and be held legally liable on its own. They offer the strongest protections for owners but are also costly to organize. Owners must also have meticulous record-keeping capabilities, defined operational processes, and maintain proper reporting procedures. Owners receive a paycheck (making filing personal taxes easier) and also pay dividends to shareholders.
An S Corporation (S Corp) is a special corporation. S Corps allow profits and some losses to go through the owners’ personal income without being subjected to corporate tax rates. However, it is crucial to understand what your state requires because not all states are the same. And the IRS has a different process for filing for S Corp status. S Corps cannot have more than 100 shareholders and all must be U.S. citizens. But they also have their own legal status, like a C Corp. In order to be able to file as an S Corp, there are specific criteria that must be met.
There are other Corporation classifications, such as a B Corporation (Benefit), Close Corporation, and Nonprofit Corporation, and then there is a Cooperative business structure. These are lesser known but also serve specific purposes.
Each business structure has specific registration and tax filing requirements. Contact me today to discuss what’s best for your business.