Starting a new business is filled with decisions and one of the most important ones you’ll make is the business structure. The structure you choose will influence everything from your day-to-day business operations and how you’re taxed to your personal liability.
Common Business Structures
Before you can register your business with the state, you’ll need to choose a business structure. The most common business structures for small businesses include sole proprietorship, partnership, limited liability company, s-corp and c-corp. You’ll want to choose the business structure that gives you the right balance of legal protections and benefits.
Sole Proprietorship
A sole proprietorship is the simplest and easiest to business structure to form. In fact, you’ll automatically be considered to be a sole proprietorship if you conduct business activities and don’t register as a different structure.
- Pros: It gives you complete control of your business and is simple and free to set up
- Cons: Does not separate your business assets and liabilities from your personal ones, meaning you can be held personally liable for any business debts or obligations.
- Best for: It can still be a good choice for low-risk businesses or owners who want to test their ideas before forming something more formal
Partnership
Partnerships are a simple, unincorporated business structure for businesses with multiple owners. There are three partnership options: general partnership where everything is divided equally among the partners, limited partnership where the general partner has unlimited liability and is responsible for paying self-employment taxes and all other partners have limited liability and limited liability partnership where every owner has limited liability and each partner is protected from debts against the partnership.
- Pros: Partnerships are simple to form, allow you to share the financial burden
- Cons: A general partnership is not a separate legal entity and typically you and your partners will be held personally liable for any business debts or obligations. You may also be liable for the debts incurred by the actions of other partners.
- Best for: Partnerships work well for businesses with two or more owners and professional groups (like attorneys), as well as groups who want to test their business idea
Limited Liability Company (LLC)
An LLC is a business structure that provides legal protection against personal liability without the more complex compliance requirements of a corporation. It separates personal assets from business debts, is relatively simple to form, offers options when it comes to taxes and flexible management, making it a popular choice for small businesses.
- Pros: Provides protection to your personal assets and allows “pass-through” taxation which helps you avoid double taxation
- Cons: Owners will need to pay self-employment taxes in addition to income taxes, there are formation and depending on your state, annual fees and more paperwork than a sole proprietorship or general partnership.
- Best for: LLCs can be a good choice for higher-risk businesses, owners with significant personal assets and any small business looking to balance personal asset protection and simplicity
C Corporation (C-Corp)
A corporation is a legal entity that is separate from its owners. It offers the most protection from personal liability, but it also requires the most work and cost to form. It requires extensive record keeping, operational processes and reporting.
- Pros: It offers the strongest protection to its owners from personal liability, owners are able to raise funds through the sale of stock, which can also help attract employees
- Cons: Corporations are the most complex and expensive to set up and operate, require more extensive record-keeping, operational processes, and reporting and they are required to pay income tax on their profits – sometimes twice
- Best For: Corporations are also a good choice for higher risk businesses, as well as businesses that need to raise money from investors or plan to go public or eventually be sold.
S Corporation (S-Corp):
An S corporation, or s corp, is a special type of corporation that can help you avoid the double tax drawback of c corps. S corps allow profits, and some losses, to be passed through directly to owners’ personal income without being subjected to corporate tax rates. However, in an s-corp you must have a reasonable wage, so you need to pay yourself in a traditional payroll setting with a W2.
- Pros: S-corps offer the same protection to its owners from personal liability with the added benefit of allowing profits to be passed through to shareholders’ personal tax returns to avoid double taxation
- Cons: There are specific IRS criteria that a business must meet in order to qualify
- Best for: S-corps work well for high earners and businesses looking to save on employment taxes
Factors to Consider When Choosing a Business Structure
Before you decide which business structure is best for your business you’ll want to think about:
- How much personal risk you are willing to take on
- How the different structures will affect your tax filing and potential tax benefits
- How you want to manage your business
- The growth and future of your business
Consult with Arsenault CPA Firm
Consulting with a business advisor, attorney or accountant can help you make the best decision for your specific situation. As a licensed accounting firm based out of Gallup, New Mexico, we offer high-quality, professional accounting, bookkeeping, tax strategies, and financial management solutions to help you build a successful, compliant and profitable business. We can answer any questions you have about the different business structure options, help you decide which one is best for your business and help you set it up. Contact us today for a free consultation.