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Updated: March 27th, 2020
Your company structure will decide how you (or the business) pay taxes, who is responsible for any unforeseen dilemmas, and how much individual power you have within your business. It is important to evaluate all possible options when choosing a business structure. Making an uninformed choice may make business substantially harder down the road.
Sometimes entrepreneurs choose to establish a hybrid business structure to reap the tax benefits of one model with the liability model of another. These types of businesses are more common among professionals such as lawyers, doctors, and engineers. They also mainly benefit from protection against certain types of contract-driven lawsuits.
As you determine which business structure is right for your business’ needs, it’s important to weigh the benefits that each offers for your needs and vision of the future. Every company structure will come with different financing requirements, options, and opportunities. Additionally, each will have other provisions that govern how your company can be organized and taxed.
Each type of business structure has its own reporting, taxation, and supervisory structure requirements. This information can be found in greater detail at the Small Business Administration website, and is important to know before choosing a business structure. A brief overview reveals many similarities.
So, you may be wondering how to choose the right business structure. This comes down to learning about the different types of business structures out there, including the benefits of each.
Although a few hybrid businesses do exist, they are often expensive and difficult to set up. General businesses rarely need the protections outlined by a hybrid company structure like an LLP.
The following types of business structures account for the majority of businesses in the U.S. and are generally inexpensive in their setup. Knowing your options can help as you determine how to choose the right business structure. The different types covered here include: corporations, limited liability companies, partnerships, and sole proprietorships.
C chapter corporations are likely to be exactly what most people think of when they hear “corporation.” Choosing a business structure like this requires board meetings, shareholders, a board of directors, quarterly and annual reporting, and more. These companies may include non-U.S. citizen shareholders. C-corps are subject to double taxation, however, unlike other types of business structures listed below.
Some immediate benefits of C-Corporations include:
C-Corporations share one common thread with each type of other business structure in our list: Ownership requirements determine which type of business you can register. They have a single membership limitation and a one-shareholder minimum. There is no shareholder maximum. C-Corporations have no citizenship requirements.
C-Corporations are required to pay taxes twice . The practice of double taxation comes from paying corporate income tax and then paying taxes on disbursements as well. Disbursement taxation includes dividend and payroll taxes.
Subchapter S Corporations (also known as an S-Corp) are limited to a maximum of 100 shareholders and must follow the same reporting and oversight requirements as a C chapter corporations, including shareholder and directors’ meetings. These companies provide the same protections as a C chapter corporation without the double taxation drawbacks. As you consider how to choose the right business structure, keep in mind that the catch is this: they have to be small and cannot include any non-U.S. citizen owners.
Some reasons people choose S-Corps over C-Corps:
S-Corporations have three membership limitations, one shareholder minimum, and a strict 100-shareholder limit. S-Corporations must be owned by U.S. citizens.
S-Corporations, unlike C-Corporations only pay taxes at the shareholder level, federally. Shareholders generally pay only personal taxes because S-Corporations are a pass-through entity.
Tax obligations for S-Corp shareholders may vary by state. Under this company structure, they, federally, will not pay taxes on corporation income. S-Corporations may be liable for state taxes, such as sales and use tax, payroll taxes, and more.
Limited Liability Companies offer many individual protections without the same reporting and oversight requirements that corporations must obey. Businesses with this company structure are often used to test an idea before refiling and officially starting a corporation. LLCs offer individual protections without double taxation.
Choosing an LLC as your business structure as opposed to the other types offers the following benefits:
LLCs share structural requirements with C-Corporations: They have only a single membership limitation and a one-shareholder minimum. LLCs do not have a shareholder maximum. Additionally, this type of business structure has no citizenship requirements.
LLCs have a distinct advantage that can influence how you choose the right business structure. They can elect, under the right conditions, to pay any one of the following sets of taxes:
Limited Liability Partnerships give partners in the business protection from each others’ actions while still avoiding oversight requirements from other company structures. In LLPs, legal responsibility is shared only between a partner and general partner, protecting other participating partners from any suits that may be filed against an individual partner.
Commercial debts, however, are shared by all partners in the LLP. Partnerships are a common business structure for testing new ideas and for shared professional firms such as offices of lawyers, doctors, and engineers.
LLPs share some structural requirements with C-Corporations and LLCs: LLPs have only one membership limitation and a two-shareholder minimum. They do not have a shareholder maximum or citizenship requirements.
Partners in an LLP are taxed similarly to an S-Corporation. They should only pay personal taxes at the federal level; state tax obligations may differ.
A sole proprietorship is a type of business structure that does not separate responsibility or assets of the business from personal ones. If something goes wrong as a sole proprietor, you are the only one responsible. A sole proprietor accepts full responsibility for the actions and decisions of their business, but they also receive all of its profit.
Sole proprietorships have access to structural benefits including:
Sole proprietorships are allowed to have one and only one owner. There are no citizenship requirements or limitations for sole proprietorships.
Business owners who choose this company structure should only be liable for personal taxes.
Partnerships are based on a documented agreement to do business together. In a standard partnership, anyone involved will accept responsibility for their partners’ actions. When choosing a business structure and considering financing options, remember that partnerships are less likely to receive loans than a registered corporation but more likely than a sole proprietor.
Partnerships gain access to benefits such as:
Partnerships, like LLPs require two members, but do not have membership maximum limits. There are no citizenship requirements for partnerships.
Partnerships can elect for either self-employment or personal tax obligations.
Learning how to choose the right business structure is the first step on a long journey of entrepreneurship. Businesses looking for more information on operations, growth and finance can seek more information through our Resource Center.
Louis DeNicola is the president of LD Money Media LLC and an experienced finance writer who specializes in credit, personal finance, and small business finance. Within the small business sphere, he helps business owners understand their financing options, cash flow management, business credit, and taxes. In addition to Funding Circle, you can find his work on BlueVine, Credit Karma, Experian, Wirecutter, and Lending Tree.