Business Entity
Choosing the right legal structure is a necessary part of running a business. Whether you’re just starting out or your business is growing, it’s crucial to understand the options. Your business’s legal structure determines your tax rates, management and paperwork requirements, fundraising abilities, and more. Sole proprietorships and partnerships are relatively easy to start, but they lack liability protection.
Corporations may take more work to start, but they offer liability protection and, in some cases, more favorable tax rates. This article is for business owners looking to learn more about the different small business legal structures.
Your business’s legal structure has many ramifications. It can determine how much liability your company faces during lawsuits. It can put up a barrier between your personal and business taxes – or ensure this barrier doesn’t exist. It can also determine how often your board of directors must file paperwork – or if you even need a board.
We’ll explore business legal structures and how to choose the right structure for your organization.
Why is a business legal structure important?
Choosing the right business structure from the start is among the most crucial decisions you can make. Here are some factors to consider:
Taxes:
Sole proprietors, partnership owners and S corporation owners categorize their business income as personal income. C corporation income is business income separate from an owner’s personal income. Given the different tax rates for business and personal incomes, your structure choice can significantly impact your tax burden.
Liability:
Limited liability company (LLC) structures can protect your personal assets in the event of a lawsuit. That said, the federal government does not recognize LLC structures; they exist only on a state level. C corporations are a federal business structure that includes the liability protection of LLCs.
Paperwork:
Each business legal structure has unique tax forms. Additionally, if you structure your company as a corporation, you’ll need to submit articles of incorporation and regularly file certain government reports. If you start a business partnership and do business under a fictitious name, you’ll need to file special paperwork for that as well.
Hierarchy:
Corporations must have a board of directors. In certain states, this board must meet a certain number of times per year. Corporate hierarchies also prevent business closure if an owner transfers shares or exits the company, or when a founder dies. Other structures lack this closure protection.
Registration:
A business legal structure is also a prerequisite for registering your business in your state. You can’t apply for an employer identification number (EIN) or all your necessary licenses and permits without a business structure.
Fundraising:
Your structure can also block you from raising funds in certain ways. For example, sole proprietorships generally can’t offer stocks. That right is primarily reserved for corporations.
Potential consequences for choosing the wrong structure
Your initial choice of business structure is crucial, although you can change your business structure in the future. However, changing your business structure can be a disorganized, confusing process that can lead to tax consequences and the unintended dissolution of your business.
Types of business structures
The most common business entity types are
- Sole proprietorships
- Partnerships
- Limited liability companies
- Corporations
- Non profit
- Cooperatives