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Entity Formation Fee Comparison Chart by StateLLC vs. Corporations: Which Structure Is Right for You? Sole Proprietorship Starting Your Own Business Partnership Limited Liability Partnership General Partnership
Legal Structures For Small Business
This page is dedicated to helping you choose the best structure for your business. Through this exercise, you will actually make two separate, but related, decisions: legal structure and tax treatment.
Types Of Organizational Structures For Companies
The choice of corporate structure involves two interrelated decisions: the decision about the legal structure and the decision about the tax treatment. While vocabulary like “an LLC taxed as an S-Corp” can be intimidating at first, you will soon master the vocabulary of the most common legal structures (sole proprietorship, partnership, Corporation, and Corporation) and tax treatment (disregard entity,). S-Corp and C-Corp). Use our comparison chart to navigate these options. You will discover which legal structure best suits your business and which tax treatment is most beneficial.
Choosing the right business structure allows for long-term success. Depending on your needs, you can choose the optimal structure for:
This page provides general guidance on the most common options. Please seek the guidance of a licensed attorney or accountant for personal advice.
This structure is owned and operated by one person. It’s simple, cheap and quick to set up. No separate legal entity was created. A sole proprietor is subject to unlimited liability; A lawsuit against a company is likely to put personal assets at risk and vice versa.
Small Business Considerations: How The Legal Structure Affects Your Tax Obligation
In a general partnership (GP), all parties are usually owner-operators. Rights and obligations are usually proportional to ownership.
A limited partnership (LP) consists of a general partner with unlimited liability who manages the business and one or more limited partners who act as silent investors.
LLCs are popular for good reason. LLCs combine the protection of corporate liability and pass-through taxation available to sole proprietorships and partnerships.
Businesses that will directly generate substantial income or involve complex ownership arrangements typically consider a corporation or LLC taxed as a corporation.
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C-Corp and S-Corp are not legal structures. They refer to two tax options that can be made for an LLC or corporation. Generally, “S-Corp” refers to a corporation that is taxed as an S-Corp, and the same is true for “C-Corp”.
Partners determine the management and profit sharing of the business in a document called a partnership agreement. GP owners have total control over the company’s operations and profits. Only general partners in an LP can exercise control.
An LLC is owned by members who receive profits per percentage of their ownership or as defined in the operating agreement. Members can organize their own LLCs, known as “member-managed,” or they can declare the LLC “manager-managed” and appoint a manager.
Often, companies issue shares to shareholders who invest in the company in anticipation of profits. Shareholders elect a board of directors to oversee the company. In a small company, one person can hold several positions.
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LP: Limited partners can only be investors. General partners can participate in management decisions but lack liability protection.
Most small businesses start with pass-through taxation (similar to a proprietorship or partnership). An LLC can make a special election to be taxed as an S-Corp or C-Corp, which helps save taxes as the business grows.
By default, the company is taxed as a C-Corp. This results in double taxation of the company’s profits and distributions to shareholders. Many small businesses choose to elect S-Corp taxation so that the corporation is taxed as a pass-through entity (like a partnership).
The diagram above shows only the most popular business structures. There are many more specialized business structures, often aimed at specific goals.
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If your organization has an altruistic mission, creating a legal and fiscal structure is an important step in formalizing support for your cause. It is most common for nonprofits to form nonprofit corporations, although some states also allow nonprofit LLCs, nonprofit trusts, and unincorporated nonprofit associations. After incorporation, you can apply for 501(c) and other tax exemptions.
Generally, partners in an LLP are protected from debts, obligations and liabilities resulting from the negligence, misconduct, or wrongful conduct of the other partner. This makes them different from GP and LP; they give some or all partners limited liability (depending on the jurisdiction). Generally, while GP or LP requires a partner with unlimited liability, LLP and LLLP do not. This structure is popular with (and in some states limited to) attorneys, accountants, and other licensed professionals.
Lawyers, doctors, accountants and other licensed professionals are limited in the legal entities that are allowed to be formed. Limits vary by state, and options often include a professional corporation, a professional LLC, or a professional LLP.
Companies that are closely related to the same entity are “closely held”. They are owned by a small number of private parties such as family members.
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A Benefit Corporation (B-Corp) is basically a non-profit business dedicated to a non-profit purpose. This relatively new type of business seeks to achieve public benefits, environmental benefits, employee benefits, other social benefits; maintain standards in terms of operational transparency; and often achieve third party certification.
The company does not pay corporation tax; instead, all profits, losses, deductions and credits are reported in the owner’s tax returns, and business taxes are paid at the personal income tax rate.
Like a pass-through entity, all profits, losses, deductions and credits are reported in the owner’s tax returns, and business taxes are paid at the personal income tax rate. Owner-employees realize savings on self-employment taxes. S corporations are responsible for taxes on certain built-in gains and passive income.
C-Corporations suffer from double taxation: Corporations pay taxes on profits, after which shareholders pay taxes on their distributions. C-Corp taxation is appropriate if the benefits of deducting employee contributions and income sharing outweigh the costs of double taxation. Small businesses that want to invest most of their profits into the business can take advantage of the low tax rate on retained earnings.
Small Business Organizational Chart Examples
Each owner reports their share of the business’s profits, losses, deductions and credits on their personal tax return (often Schedule 1040 Schedule C). You pay tax on your share of the company’s income at your personal income tax rate.
S corporations are responsible for taxes on certain built-in gains and passive income and must file Form 1120S.
Each owner reports wages and distributions on their personal tax return (often Form 1040). You only pay tax on wages and capital gains at your personal income tax rate. Distributions experience corporate double taxation, as both you and the company pay taxes on this income. Salaries are deducted from the company’s income before paying corporation tax (they do not suffer from double taxation).
For example, if you decide to be taxed as an S-Corp, you can structure your business as an LLC or corporation. It helps to consider your legal structure and desired taxation independently, then refer to this chart to see if the desired combination is available.
Creating An Organizational Chart For A Small Business
If you’re starting a small business and feel overwhelmed navigating business structure and tax treatment for the first time, you’re not alone. This section is written for you. We review five considerations to help make your choice.
By “small business” we mean businesses that have only one or only a few owners. These include mom-and-pop stores, retail stores, consumer services, and business-to-business services. 90% of small businesses only need to consider two options:
This structure is cheap to start, easy to run and allows you to save money on taxes with pass-through taxation.
Here’s why other structures you’ve heard about don’t make sense for new small businesses:
Types Of Partnerships
Does your business name include your legal last name? If not, your state may require you to register your business name.
Let’s use the example of John Doe, who is ready to take his passion for lawn decoration flamingos and turn it into a business. He did not have to register the name “John Doe’s Lawn Ornaments” because it included his legal name. But he should have registered “Flamingoes Galore Lawn Ornaments” because he didn’t.
To meet the requirements for registering a business name, you can register a fictitious name (to start a sole proprietorship or partnership) or file articles of incorporation for an LLC or other business entity.
Registering a business entity (such as an LLC) provides the added benefit of limited liability. Limited liability is what protects your personal assets if the company is owed or sued. Your home, your car, your retirement account and your children’s school funds are still yours.
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Limited liability should be the main concern of most owners. It is often not until owners discuss their risks that they realize their exposure. Any business that has a physical location, employees or sells products or services that can be disruptive (e.g. food poisoning) is at risk of liability.
A common misconception is that you should not be limited