Only an individual or a married couple can own a sole proprietorship. This structure is known for being simple to set up for most small business owners. Once you’re registered and licensed with your state and local governments, you’re ready to go.
Sole proprietorships also make it easy to file federal taxes by adding Schedule C – Profit and Loss from a business to your individual Form 1040. This business structure is also a pass-through entity, which means there’s a 20% tax deduction under the recent tax reform for 2018.
One important fact to remember about sole proprietorships is that your personal assets have no legal protection. So, if there’s a mistake in your products or services, you’ll be personally liable. This means you may need to pay for these errors out of pocket, which could completely drain your bank account.
If your business is in an industry where lawsuits are not very common, a sole proprietorship may be a good option. To decide, you’ll want to evaluate the level of personal risk you’re willing to take.
A general partnership is similar to a sole proprietorship, except there are two or more owners of the business (who aren't a married couple). These business owners have a partnership agreement and are co-owners of the business. They share all rights and responsibilities.
This means that taxes are not paid by the business, but instead flow through to each partner’s individual return. General partnerships also have a 20% tax deduction due to the recent tax reform.
One downside to this business structure is that there is no liability or professional indemnity protection. This puts each owners’ personal assets at risk if someone sues their business. Banks are also reluctant to provide capital for general partnerships and prefer limited partnerships or corporations instead.
However, if you’re looking to run a business with a group of people and not on your own, general partnerships are a great structure to consider.
A Limited Liability Company (LLC) is a hybrid business entity that shields owners' personal assets from business liability but allows the income they earn to be taxed once as personal income. On top of this, LLC’s can have an unlimited number of members. They’re also required to file a tax return, but their actual earnings are not taxed separately. Instead, they pass through to the members who pay the taxes on their individual income tax returns. If you form an LLC, you’ll also receive a 20% tax deduction under the recent tax reform because LLC’s are considered a pass-through entity.
One drawback to LLC’s is that their lifetime has a limit of 30 or 40 years. They can also have higher costs and be more complex than other structures. If your company generates a lot of cash, this may not be the best structure for you. In contrast, if you have a small group of owners and need liability protection, LLC’s can be beneficial.
A limited partnership is a complex business structure with two classes of partners: limited (LP) and general (GP). For GP partners, a limited partnership is easier to set up than a corporation. LPs raise capital and have no say in running the company. However, they do get ownership in the business without any responsibility.
The profits made are then passed through the partners and taxed on individual returns. Limited partnerships also receive a 20% tax deduction from the recent tax reform.
One downside to limited partnerships is that there is a high risk of lawsuits and debt. GPs face all liabilities of the partnership and LPs liability matches their investment in the business. In many cases, lawyers choose this structure because they cannot become LLCs or corporations. It’s also a structure used for projects that have a limited time frame.
C Corporations are a legal entity with a charter granted by the state they’re in. These corporations can sell shares of stock to raise money, and shareholders become owners with an interest based on the size of their investments. This business structure provides the best protection against liabilities. There are also no limits to the size of investments or number of investors, which attracts equity investors more.
On top of this, C corporations can offer employees tax-deductible benefits, like medical insurance and retirement plans. There are also no limits on the number, national origin or nature of shareholders when it comes to raising capital. The recent tax reform in 2018 offers a reduction in the tax rate for C corps from 35% to 21%.
While this business structure shields its owners from liability, it takes a lot of time and resources to get one up and running. You’re also subject to double taxation on corporate profits and on dividends paid to shareholders. This makes it difficult for many startups to succeed in this business structure. However, larger businesses may find that it’s a good option.
An S corporation is structured like a traditional C corporation, except that a special classification from the IRS exempts earnings from double taxation. Your earnings as an S corp will flow through your individual tax return. You’re also protected from personal liability. S corporations also benefit from the 20% tax deduction that pass-through business entities receive under the new tax reform.
One disadvantage is that there are no more than 100 shareholders allowed. These shareholders cannot be foreigners or other corporations. Owners can also only create one class of stock.
S corporations are good for many small businesses. However, if you’re pursuing a lot of shareholders or venture capital financing, this structure isn’t for you.
Professional Corporations (PCs), Professional LLCs and Limited Liability Partnerships (LLPs) are versions of basic business structures that provide some liability protection for certain types of professional firms, like medical and legal practices. These may face enhanced liability risk.
1 Small Business Administration (SBA), “Choose a Business Structure”
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