The four most common business structures are the sole proprietorship, partnership (general or limited), corporation, and limited liability company (LLC). Determining which structure would best suit your business can depend on several different factors. Keep in mind that your business structure can be changed at a later time, as your business needs change.
The first factor to consider is how important liability will be to your business. If there is the possibility that it could be sued in any way or accrue debt, then it is probably best to avoid being a sole proprietor or a general partner. Both forms do not provide any personal liability protection from business creditors. Also, if you have personal debt or are prone to having personal creditors, then these two business structures will not protect your business assets from your personal creditors.
If liabilities are a major concern, you can avoid the double taxation and formalities of many of the business structures, and opt for a sole proprietorship or general partnership. Legally, they are simplest business structures to form and operate. Keep in mind that even though an owner is only responsible for his or her own personal tax income, it is still best to keep the business finances separate from one’s own personal assets. Allowing business and personal finances to merge may make it difficult to calculate business profits and manage finances efficiently. For example, the IRS allows deductions for interest payments for a business, but not for personal interest payments.
The next major factor in choosing a business type is how the business will be taxed. A drawback of the traditional C corporation is that it is taxed at both the corporate level and when distributions are made to the owners. This is known as “double taxation”. Sometimes this is desirable because it keeps the owners out of a higher tax bracket, but generally, if a company wishes to minimize taxes, a “pass through” business type is usually the model of choice. This means that the business itself is not taxed. All business profits or losses are passed through to the owners to report on their own personal tax returns.
The most popular “pass through” business structure currently is the LLC. The LLC also provides limited liability to its business owners, known as “members”. This coupled with the relative freedom that an LLC has over government rules and regulations for business operations, makes it the first business type that should be considered by a budding business. One drawback of the LLC is that it is a relatively new business form, so there is not a lot of uniformity among the states on the requirements for forming an LLC. For this reason, it is highly recommended that you consult with an attorney prior to making your first steps in forming a business so that you can be well informed on your state’s current requirements and regulations.
Some states do not allow a single member LLC. In these states, the most viable option then is usually the S corporation. It is taxed similarly to the LLC, but it does have more restrictions. For a partial list of S corporation restrictions, refer back to the corporation section.
Another factor to consider is how the business will be financed. If outside investors will be necessary, then a limited partnership, corporation, or LLC may be the route to pursue. These structures allow an individual to invest in your business without taking on a managerial role or being personally liable for any of the business debts or obligations.
It is important to have a firm understanding of the various business types and government regulations prior to starting a business. For more advice on selecting a business organization, you should consult an attorney. An attorney can provide additional details on the various business types and help you choose the one that is best suited for your needs.
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