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| Business structure | Best for… | Ownership | Liability | Which taxes apply? |
|---|---|---|---|---|
| Sole proprietorship | A simple setup with limited paperwork | One owner | Owners are personally liable | Personal taxes |
| Partnership | Testing new ideas with other business owners | Two or more owners | General partners are personally liable, limited partners are not |
|
| LLC | Avoiding personal responsibility for the business with a more relaxed structure than a corporation | One or more owners | Business is liable |
|
| Corporation | Establishing an easily scalable business that you might want to sell one day | One or more owners | Business is liable | Varies by type of corporation:
|
Some business structures like a sole proprietorship or partnership require personal taxes because of something called “pass-through taxation.” Pass-through taxation means that the owner or customers are responsible for taxes, instead of the business. With pass-through taxation, an owner might pay income taxes on its profits. Or a customer might pay taxes in the form of sales tax.
A sole proprietorship is a business run by one person where there is no legal difference between the owner and the business. This means you’re responsible for all debt or legal actions taken against the business.
You don’t have to do anything to set up a sole proprietorship unless you want to operate under a name other than your own. In that case, you have to register your “Doing business as” (DBA) name for your business in most states before you can legally operate.
Even if you have a DBA name, keep in mind that there’s legally no difference between you and your business.
While there’s not a separate business structure for your business, you’re still required to apply for licenses and permits for your business. For example, you need a license from the Alcohol and Tobacco Tax and Trade Bureau if you’re starting a one-man brewery. Otherwise, you risk facing a lawsuit or getting shut down.
Sole proprietors report profits as income on their personal taxes.
A partnership is a business owned by two or more people, where all owners split control of the business — and share the profits and losses. There are several different types of partnerships:
You can form a partnership by registering with your state and writing up a partnership agreement. While not required, a partnership agreement outlines the terms and conditions of the partnership.
It should state the responsibilities of each partner, outline what types of roles each partner plays in day-to-day operations and describe how profits are split. It should also outline how the partnership deals with certain situations. Otherwise, it’s up to state law. A partnership firm dissolves automatically if one or more of the partners leave the firm or upon the death of a partner.
Each partner is responsible for paying a personal income tax on their share of profits. General partners also typically have to file self-employment tax.
A limited liability company (LLC) works like a cross between a sole proprietorship and a corporation. Owners — known as members — aren’t legally responsible for the business, but you can still avoid paying a higher corporate tax rate by paying income tax on the profits. But if you change the structure of your LLC — say you want to add another member — you might have to dissolve and restructure the company depending on your state laws.
Typically, you have to file articles of organization or a certificate of formation with your state in order to set up an LLC, depending on your state laws. You also might want to have an operating agreement, which works a lot like a partnership agreement. This establishes ownership percentages and states how profits and losses are distributed between members, as well as voting rights on major decisions. If an operating agreement is never drawn up, state rules apply to the LLC.
LLCs have a few tax options. If you have a single-member LLC, you can be taxed as a sole proprietorship. And two-member LLCs can be taxed as partnerships. But you might have to file self-employment tax. Otherwise, you can choose to be taxed as a C-corporation or S-corporation.
A corporation works by completely separating legal liability from its owners — in fact, it’s its own legal entity. Its profits are divided between shareholders based on the percentage of the company they own, but shareholders aren’t liable for a corporation’s debts. Each shareholder gets one vote per share they own on major company decisions. The original owners — or shareholders — can eventually sell off the corporation to another set of shareholders by “going public.”
A corporation will exist forever if a firm end date hasn’t been decided. This means that the corporation can continue to operate despite any change in status ranging from disbanding of directors, death of the owner or sale of the company. A corporation only ends when it is liquidated and all assets are sold and creditors are paid – anything left can be split between shareholders.
Corporations involve the most paperwork compared to other types of business structures, though it can vary by state. You generally must file articles of incorporation with your state, sell stock to the new company’s shareholders and elect a board of directors. The board of directors is responsible for coming up with the business plan and the general management of the corporation.
Corporations are often required to report company standings in the form of quarterly or annual financial statements.
There are a few types of corporations that work slightly differently — mostly when it comes to taxes:
Choosing which structure to use for your business depends on your long-term financial goals. Here are some things to keep in mind when deciding:
Consider your legal responsibility, tax obligations and the work it takes to set up and maintain different business structures before you decide which one to choose. After you’ve picked your business structure, you’re ready to start thinking about how to create a business plan — which you need to attract investors or apply for a business loan.
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