Choosing the legal structure of your business isn’t the most exciting part of starting a new venture, but it’s one of the most crucial ones. Your structure will heavily impact the way your business grows and also influence elements such as taxation and liability. It’s an important decision that needs to be taken carefully.
It can be easy to get lost in a pros and cons comparison so we’ve prepared a list of the most common business structures for small business owners and entrepreneurs.
Sole proprietorship
How it works: This is the default organisational form with no application required. Depending on the nature of your business and your state of residence, you may still be required to register or request a business licence.
Pros: For a low cost, this is a simple option allowing you to try out your business idea with almost no hassle.
Cons: There is no personal liability protection in a sole proprietorship. A suit against your business can impact your personal affairs and end in a claim against your personal assets.
Partnership
How it works: A partnership is owned by two or more individuals. In general partnerships, everything is shared equally, while in limited partnerships, only one partner has control of operations.
Pros: Another low-cost and simple option. Each partner files the profits or losses of the business on their own personal income tax return.
Cons: In a general partnership each partner is individually liable for the debts and obligations of the business. In a limited partnership the general partner is fully liable.
Limited Liability Company (LLC)
How it works: A LLC combines some of the characteristics of sole proprietorships/partnerships (pass-through income taxation) and corporations (limited liability).
Pros: LLCs are relatively easy and inexpensive to set up with no limit on the number of shareholders. Liability protection from business operations such as lawsuits is a major benefit.
Cons: Depending on how you set up your business entity, you may end up having to pay self-employment tax on your share.
S-Corporation
How it works: The S-Corporation is the most common form of corporation. S-corps are designed for small businesses, with income and losses passed through to shareholders with just one level of federal tax to pay as a result.
Pros: Shareholders aren’t personally liable for corporate debts and liabilities. Your share of the S corp’s net income will not be subject to self-employment tax.
Cons: An S-corp may not have more than 100 shareholders, who must all be US citizens or permanent residents. Formation and ongoing expenses are costly.
Takeaways
There is ideal business structure for your business, but determining your main goal ahead of time will help you pick the best one.
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