Opening the doors your first day of business feels something along the lines of meeting your soulmate and having your first child. But what really makes your business sink or swim is the prep work you do ahead of time. Along with the business plans and the marketing strategies, an important piece of the puzzle is how you legally structure your business. Your business structure affects your taxes, your ability to raise funding, and also in some ways, your flexibility as a business owner. In this Starting Your Business, we’re exploring the five most common types of U.S. businesses along with some of their pros and cons.
Five Common U.S. Business Structure Types
This is a quick look at these common business structure types. For more information on the tax implications of each one, the IRS provides a handy guide. And if you’re interested in the legal side, NOLO has an easy-to-understand resource here.
Sole Proprietorship
A sole proprietorship is just like it sounds: you doing your business. In a sole proprietorship, you are the business. The business runs under your name, and you’re personally, financially and legally responsible for debts and lawsuits.
The good.
This is the easiest way to form a business. You don’t have to fill out mountains of paperwork or pay heavy fees just to open your doors. It’s just you sharing your genius with the world.
The bad.
If, heaven forbid, one of your customers decides to sue you, or if your business goes bankrupt, guess whose personal assets end up being at stake? That’s right. Yours. If you’re in a highly regulated industry or doing work with high liability, you should probably consider one of the other business types.
Partnership
While there are a few different types of partnerships, including some that limit liability and management, a basic partnership is essentially the same as a sole proprietorship. Only in this business structure, you’re in business with someone else. Taxes and liabilities are similar.
And while no paperwork is necessarily required, we always want to Begin With The End In Mind. You need an agreement in place to handle how you’ll exit, what to do if there are disagreements, how profits are divided, etc.
The good.
It’s a fairly simple setup. But that’s about it.
The bad.
There is always the possibility of butting heads with your partner. If they make a bad business decision, you’re equally responsible. (Can we just say yikes!) And if your partnership is not set up correctly, you could face sharing profits equally with a partner who doesn’t carry their weight. Partnerships aren’t bad by design, but good legal advice is a must-have for this business structure.
Limited Liability Company
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A Limited Liability Company (LLC) means just that: limited liability for the owner. There’s some paperwork to file and a fee to pay–from $500 in Illinois or Massachusetts to $40 in Kentucky. Some states also require a yearly fee while others don’t, so check your state’s LLC guidelines.
The good.
Limited liability is a really good thing for you. In the case of bankruptcy or lawsuit, your personal assets are almost always protected. Another benefit? Unlike S or C corporations, the record keeping is pretty minimal.
The bad.
The LLC tax situation isn’t great. You’re still taxed like you’re self-employed, so you end up paying more in taxes than other corporations. In some cases, LLCs can get an S-corp tax status, however, so be sure to work with a good lawyer who can help you leverage your tax structure.
S Corporation
An S Corporation (S corp) is a corporation with special tax status with the IRS. Basically, this business structure allows for pass-through taxes. That means profits and losses pass through to your personal taxes. The S corp isn’t taxed like a business, and you aren’t taxed twice.
The good.
Obviously, the taxes! You’ll be able to save a decent chunk of change if you choose this business structure.
The bad.
You’ll be more highly regulated, and you’ll need to pay careful attention to record keeping. There are also wage requirements with this structure, so be sure to work with a good lawyer when you set this type of business up.
C Corporation
This is a full-blown corporation. This is the business structure most people think of when they hear the word corporation. You’ll have all the financial protection you need should business not go as planned. And you can raise capital and have investors.
The good.
Protection. Outside capital. It all sounds pretty good right?
The bad.
Be ready for loads of paperwork and record keeping. C corps are often taxed twice as well, and the government will be watching closely to make sure you have everything in order. The C corp structure works best for larger businesses.
When you’re ready to choose your business structure, working with good legal counsel who can walk you through the steps is the best advice. Even a simple business that is a sole proprietorship should engage a lawyer for help with thorny issues.
And successful businesses grow and change. So keep in mind, if you start with a simpler business structure like a sole proprietorship or LLC, you can always switch to a more regulated business structure if necessary. But once you set up as a more regulated business structure, taking your business back to an LLC is tricky.
Business Owner Only Community Question: What business structure did you choose and why? Did anything you learned today lead you to reconsider that choice? Share your experience with the community here!
image credit: Bigstock/peshkov
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Dr. Tony is the co-founder of MindShift.money and the best-selling author of three books on personal and business finances. Having achieved Financial Freedom at 27, Dr. Tony believes that through Financially Fit Bootcamp and Cash Flow Cure everyone can get there. He has made it his life’s mission to help others live a life where their money works for them—not the other way around.