How to choose the right business structure for your company
This article will help you identify the different types of business structures and regulatory requirements of each type of business structure.
Choosing the appropriate legal form for your business should be one of your priorities when getting your venture off the ground. But how can you choose the best business legal structure?
To make the best choice for your position, long-term objectives, and personal preferences, you should see a legal professional, but before you do, familiarize yourself with the many structures available to you. Also, when faced with a wide variety of options, making a decision might be overwhelming. This decision can be simplified, however, by the crystallization of both the business’s goal and its scope.
You need to have an idea of how much control you want, how much compliance you can handle, how much money you’ll need, and more. This article will help you identify the different types of business structures and the legal and regulatory requirements of each type of business structure.
Choosing a legal form for the company is an essential part of getting started in business. This choice may have far-reaching effects on the firm, including taxation and individual accountability. There are a few mainstays in the corporate structure world, and familiarizing yourself with each will help you choose the best one for the organization you work for.
What is the business structure of a company?
A company’s business structure is its recognized legal framework within a certain jurisdiction. The legal form of a company has a significant bearing on its freedom to engage in certain activities, such as capital-raising, liability for business responsibilities, and tax liability.
Company owners should evaluate their requirements and objectives and get familiar with the characteristics of each company structure before settling on one. Sole proprietorships, partnerships, LLCs, and corporations are the four most common types of organizations in the U.S.
How does business structure work?
Choosing the correct business structure is important because it will affect the amount of taxation your company pays to the Internal Revenue Service. It will also decide whether or not your private assets are safe from creditors making claims against your company. Factors such as how the new company will be run and where you see it going in the future are also important. It lays down the company’s ownership structure and how earnings will be shared. Changing your company’s structure down the road may be difficult and expensive, so take your time making your decision. If you want to make the best possible choice, it’s a good idea to talk it over with a business advisor, accountant, or lawyer beforehand.
Types of business structure
The road to prosperity for your company will be heavily influenced by its organizational structure. A good decision should be made from the start, even if it can be altered. Many elements must be considered and re-evaluated to arrive at the optimal business structure. Here are the several company structures available.
This is a company that is controlled and managed by a single person. There is no separation between the individual who owns and the company from a legal standpoint. Most small firms operate under the umbrella of a sole proprietorship.
- Quick to set up and inexpensive overall.
- The company is run solely by the owner.
- The owner’s assets are at risk to the full extent of the company’s obligations.
- Investors are unlikely to put money into a firm that is run by a single person.
This structure constitutes a group of individuals who get together to make money in business. The formation of a partnership requires minimal paperwork, but each time two or more people are working together, an official agreement between them is necessary. A partnership’s rules for dividing profits and losses, allocating ownership stakes, ending the partnership, and assigning managerial responsibilities are all codified in an agreement.
- Effortless in both production and maintenance.
- The business’s gains and losses are included in the owner’s tax filings.
- Each partner has individual responsibility for the company’s obligations.
- Without a formal partnership agreement, difficulties with administration and control are possible.
A business structure that combines features of corporations, partnerships, and sole proprietorships. Members are the business owners who make up a limited liability company. All sorts of companies, from sole proprietors to multinational conglomerates, may form an LLC. There is a kind of LLC that has one owner and is legal in most states.
- Owners are protected from personal responsibility for business debts by the entity’s structure.
- Members share the company’s profits and losses and pay taxes on them exclusively at the personal level.
- Accepts an infinite number of participants.
- Additional state taxes are often imposed.
- The profit earned by each member is taxable income regardless of whether or not the profit was dispersed.
The S corporation form of business is more attractive to start-ups and small firms since it provides the liability defense of a corporation and additional tax advantages. To be classified as such by the IRS, however, it must adhere to several requirements.
When a business is incorporated, it becomeshttps://incparadise.net/c-corporation/ a separate legal entity from its shareholders. Because of the greater regulatory, record-keeping, and tax compliance burdens imposed by this business structure, it is also more difficult to set up and maintain. If you’ve already got a moderate or greater-risk firm up and running and need to raise capital, go public, or sell, you may want to consider forming a corporation, frequently referred to as a C corp.
Pros of Corporations
- Shareholders in a corporation are protected from personal responsibility for debts incurred by the business.
- Typically, this is a configuration that benefits financiers.
Cons of Corporations
- The startup procedure is more time-consuming and expensive.
- There is “double taxation” of profits since they are subject to taxes both at the company level and at the personal level when distributed to shareholders.
- High board governance and supervision.
Examples of businesses that might choose each type of structure
One who operates a firm as a sole proprietor does not need to register the company with the government. Legally speaking, freelancers and the vast majority of the self-employed run what is called a “sole proprietor business”.
The shareholders of a corporation are the legal owners of the vast and intricate organization. Because of its status as a separate legal entity, the company must account for its own decisions and obligations. Unless more clarification is needed, the term “corporation” is often used in place of “C corporation” or “C corp” to refer to an ordinary company.
As opposed to C corporations, investors of an S corporation or an S corp must report their share of the company’s revenues and losses on their tax returns.
Factors to consider when choosing a business structure for your company
Given that your startup might theoretically fall under more than one category of business structure, here are the things to think about when you make your decision:
- Tax implications – Owners of sole proprietorships, limited liability companies, and partnerships must report their earnings and pay taxes on that amount as personal income. Corporations not only have to pay taxes on their earnings but also must submit their tax returns.
- Liability protection – If you form a corporation, creditors, and customers may sue the business but cannot take possession of your assets. Other business forms include limited liability companies (LLCs), partnerships (where liability is divided among partners), and sole proprietorships (where full financial responsibility rests with the owner).
- Management structure – The easiest company form to set up is a sole proprietorship, but it might be more challenging to get financing. In contrast to corporations and LLCs, which are required to file annual reports with state and federal authorities, partnerships do not need such documentation for determining responsibilities and distribution of earnings.
- Funding needs – Corporations may raise capital via stock sales and bank loans, but sole proprietors must rely on personal savings or outside investors. Although it’s common for LLC owners to dip into their savings or take out personal loans when times are tough, that’s not always required.
Legal and regulatory requirements of each type of business structure
To make an informed decision about your company’s legal structure, you should familiarize yourself with the many options available to you and how they could fit into your current plans. You may speed up the decision-making process by making sure you meet all legal and regulatory standards for your business structure. In this section, we will see how different business structures need different legal and regulatory requirements.
A solo proprietor has less regulation and much autonomy and freedom. Starting a solo proprietorship requires no documentation. If you use a business name apart from your own, you may need to register it as a DBA within the relevant state or city.
A sole proprietorship is not a legal entity, thus its assets, debts, and obligations are the same as those of the owner. Because of this, business owners take on significant risks if their company has legal or financial difficulties. Your company financing will depend on your credit, and you can’t take on partners as a sole proprietor.
Profits from sole proprietorships are taxed as income and self-employment. Sole proprietorships may be used to test a company concept before adopting a more complex business structure and its higher expenses.
There are several types of business partnerships. Going into business with others without forming a legal body is equivalent to operating as a general partnership. In a general partnership, each partner shares equally in the debts and responsibilities of the firm, just as they would if operating as a sole proprietor. They are also responsible for the acts of their partners, which is why most attorneys recommend that firms incorporate or create an LLC instead of operating as a general partnership.
Taxation of general partnerships is analogous to that of sole proprietorships in that each partner must file a separate tax return to account for his or her portion of the partnership’s income, deductions, credits, gains, and losses.
Limited Liability Company (LLC)
An LLC strikes a middle ground between the simplicity and adaptability of a partnership and the security and tax benefits of a corporation. LLC owners (sometimes called “members”) are shielded from personal responsibility for debts incurred by the company.
LLC members register and pay taxes like self-employed individuals. LLCs, however, have the option of being taxed like corporations. Articles of Organization are filed with the state to establish a limited liability company.
An operating agreement is necessary for an LLC because it lays forth the rules by which the business will be managed and the obligations of the members. LLCs are popular among entrepreneurs because they are easy to set up and manage.
To avoid paying taxes twice on its profits, an S-Corporation might choose to have its federal income taxes treated as a “pass-through” rather than as a “corporate” tax. Instead, the shareholder-owners include their part of the company’s revenues on their tax returns.
S-Corporation taxation is an option for both limited liability companies (LLCs) and corporations (C-Corps), maintaining the same liability protection for shareholders, avoiding double taxes, and accounting flexibility (unlike a C-Corp).
S Corporation stockholders must be U.S.-based corporations or citizens or permanent residents, which limits expansion possibilities. Taxing a limited liability company or a corporation as an S corporation requires more paperwork and administrative fees upfront.
The “double tax” impact occurs here because C Corporations are treated as distinct businesses for tax purposes and must pay a rate of tax on corporate income on their earnings. To register, a business must submit Articles of Incorporation with the Secretary of State and fulfill external and internal corporate standards.
The “double tax” federal business tax rate is lower than for people (income, plus benefits such as Social Security, and Medicare) in certain cases. Unlike LLCs, partnerships, and sole proprietorships, C Corps may qualify for tax deductions. Due to registration and regulatory compliance, C corporations have greater creation and operation expenses.
Need help with choosing your business structure?
Choosing a legal structure for your company is a prerequisite to registering it with the state. Most businesses also need to register for tax purposes and submit applications for required licenses and permits. The tax burden, the availability of funding, the administrative burden, and the potential for personal responsibility are all influenced by the business structure you choose.
Once you’ve settled on a business model and begun operations, you must maintain an accurate accounting of all incoming and outgoing shares. Eqvista works well for this purpose. We have an exclusive team of expert advisors to help you understand business structures better. If you need help with settling on the best business structure or keeping track of shares, you can call us now!