Choosing the right business type is the first and the most crucial decision. The structure of the business you have decided affects the overall business activities in terms of structure, your liability as to the business owner, tax obligations, as well as compliance requirements that needs to be satisfied on an ongoing basis.
However, the type of business entity with which the business started might not grow in the near future as businesses grow and expand gradually. Here are some of the most common entity types before you decide on starting your own business.
Sole Proprietorship and General Partnership
Most of the small businesses start either as a sole proprietorship or as a partnership. The owners, in this case, are either a married couple or a general partnership between two people. Also, when the business owners do not register their company formally with the state, they are, by default are considered as either a sole proprietorship or partnership with no financial or legal separation between the owners and their businesses.
- The business structure is simple and needs less complicated formal paperwork.
- The business profits and losses are directly related to the business owners in terms of tax elements making the tax filing process simple.
- Sole proprietorship entails personal liability risks. If the business is sued, the sole proprietor has to deal with all the mess.
- The business has limited growth opportunities. Outside investors will not fund the business if it is not officially registered.
Limited Liability Company (LLC)
A type of business where the sole proprietorship, corporation, and the partnership businesses traits both exists is a Limited Liability Company (LLC). Here the business owners are not personally liable for all its debts. These are liable entities where, while the limited liability feature is similar to that of a corporation, the availability of flow-through taxation to the members.
- LLC companies are subject to pass-through taxation where the business incomes and losses are reported on their personal tax returns.
- These companies enjoy flexibility in management. LLC’s that have multiple members can choose to be members managed or manager-managed. The structure is helpful to decide if the business owners will handle the day to day management responsibilities in the case where the business owners will handle the day to day management responsibilities.
- The business faces heavy tax burdens as it covers potentially excessive tax burdens. This also means that similar to the sole proprietorship and partnership, the taxes related to self-employment are applied to all the business profits.
- Limited Growth Opportunities cannot issue stock on its own. While the LLC can add members who can bring in additional funds to the business.
- LLCs also have a very limited lifespan. If a member departs from the LLC, the company is considered to cease.
The C Corp or the C Corporation stands for the Corporation style of the business. The C comes from the fact that C Corp income is taxed under the subchapter C of the Internal Revenue Code.
A C Corporation is a legal structure for a corporation in which the business owners or the shareholders have to pay taxes independent to the entity. Profits in this business structure are taxed at both personal and corporate levels. There are several state requirements that must be met to start a corporation.
- Structure of a C Corp business provides the highest level of liability protection for the business owners. In most of the cases, the directors, shareholders, and the employees are protected against lawsuits and corporation debts.
- Corporations are often eligible for a higher tax deduction than the business that is operating with other structures.
- These businesses also have the advantage of perpetual life.
- The rules and regulations to start and operate a C Corp are stricter than to start a company. Moreover, the procedures are complex in nature, including elements such as appointing a board of directors, filling an initial report, drifting bylaws, and developing the yearly reports.
- The federal corporate income tax rate is applied to a C Corporation’s profits. The business is again taxed against the shareholders when the profits are distributed as dividends. Such a system generates double tax as the dividends that are paid are not considered as tax deductions for this type of business.
Having a brief knowledge about all the business types, you must be thinking about changing its structure. Some of the most common reasons that may encourage you to change the business structure can be:
- Expansion in the team size
- The desire to add a business partner
- Making an attempt to seek additional funds from the investors
- The desire to cut down self-employment tax payments
- A plan to sell the business
- Or a wish to retire from work
The state in which a business is operating and the business structure plays an important role in the process to switch from one business structure to another. You can take help of an attorney or an accountant to understand wheatear a change in the business will be beneficial for you in the present market conditions.
However, ideally, it is important to think about its structure and short term as well as the long term goals. This will help you decide your needs and vision of your business.
Source – Forbes