Usually, the first thought in starting a small business is to decide the name. However, it is equally (or more) important to understand and decide the entity structure (or legal structure) under which the business will operate. First, the entity or legal structure will determine the format and forms that the business will use to file annual income taxes (regarding its net profit or loss). It will also determine how documents are signed or executed. The types of legal structures or entities used most by small businesses are a Sole Proprietorship, a General Partnership, a Limited Liability Company (LLC) or a Corporation. A corporation can also be referred to as a “common corporation” or a “C Corp”).
Single Owner
Unlimited Personal Liability
Self-employment &
Personal tax
In a Sole Proprietorship a single person owns and runs the business. It is one of the simplest business structures to setup and might be a good fit if you are planning on working alone. As the owner of a Sole Proprietorship, you are liable for all business financial obligation, both debt and losses. This structure often works well for low-risk, home-based or retail businesses. A Sole Proprietorship also can allow an owner to test their business idea before creating a more formal company.
Tax reporting is less complex than other business structures. The business legally isn’t a separate entity and as such your personal income tax return would include the businesses expenses, income and losses.
Privacy of the business is maintained because Sole Proprietorships are not required to file an annual report to federal or state governments.
One or more Owner
Unlimited Personal Liability
Self-employment, Personal or corporate tax
A Limited Liability Company (LLC) is formed by one or more individuals or entities through a special written agreement. The agreement details the organizations of the LLC, including provisions for management, assignability of interests and distribution of profits and losses. This structure works well for medium or high risk business.
Limited liability to members because an LLC is an independent entity. You are not personally responsible for debts or lawsuits against the company. This can protect the members personal assets. Speak to a law professional for specific information regarding your business.
Profits distribution is more flexible compared to corporations. An LLC has the ability to decide profit dividends amongst its members. Speak with a tax and/or a business professional for additional details regarding funding, profits and tax benefits.
One or more
Shareholders
Limited Liability for shareholders
Corporate tax
A Corporation, sometimes called a C Corp, is a legal entity that's separate from its owners. Corporations can make a profit, be taxed and can be held legally liable.
Corporations offer the strongest protection to its owners from personal liability, but the cost to form a corporation is higher than other structures. Corporations also require more extensive record-keeping, operational processes and reporting.
The profit of a Corporation is taxed to the Corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. Although owners pay a double tax on business earnings, Corporations can deduct certain benefits they provide to employees, such as retirement plans, health insurance premiums, life insurance and other related expenses.
1 - 100
Shareholders
Unlimited Personal Liability
Self-employment &
Personal tax
S Corporations are corporations that elect to pass corporate income, losses, deductions and credits through to their shareholders for federal tax purposes. Shareholders of S Corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S Corporations to avoid double taxation on the corporate income. S Corporations are responsible for tax on certain built-in gains and passive income at the entity level.
To qualify for S Corporation status, the corporation must meet the specific IRS criteria:
- Be a domestic corporation
- Have only allowable shareholders
- May be individuals, certain trusts and estates and
- May not be partnerships, corporations or non-resident alien shareholders
- Have no more than 100 shareholders
- Have only one class of stock
- Not be an ineligible corporation (i.e. certain financial institutions, insurance companies and domestic international sales corporations).
Additional Structures
You may operate your business or organization under any one of several organizational structures. Each type of structure has certain advantages and disadvantages that should be considered. Ownership, liability and tax responsibilities vary from structure to structure. The previously described structures may not fit your business needs. Click on the following resources to learn more about other business structures:
