taxed<\/strong> as businesses, while others pass the income to their owners, who are taxed personally <\/li>\n<\/ol>\n\n\n\nSeeking advice from an expert can help you choose the right structure based on your personal situation and business objectives. This post walks you through the essentials, so when you do talk to a professional, you\u2019ll be more prepared \u2014 and you\u2019ll know what questions to ask.<\/p>\n\n\n\n
Can you change business structures later?<\/h2>\n\n\n\n
Yes, but some changes are easier than others. It\u2019s relatively easy to go from a less complicated structure to a more complicated structure. It\u2019s harder to go backward. <\/p>\n\n\n\n
Many people start a business as a sole proprietorship or LLC and later incorporate, but changing from a corporation to a simpler structure is much more complicated, especially if you\u2019ve sold shares of stock.<\/p>\n\n\n\n
The common types of business structures<\/h2>\n\n\n\n
There are several business structures available in the US. Here\u2019s a simple guide to help you understand the differences between them.<\/p>\n\n\n\n
Sole proprietorships<\/h3>\n\n\n\n
Ownership:<\/strong> One owner<\/p>\n\n\n\nSell shares:<\/strong> No<\/p>\n\n\n\nPersonal protection:<\/strong> No<\/p>\n\n\n\nTaxation:<\/strong> You\u2019re taxed personally; the company does not pay its own taxes<\/p>\n\n\n\nA sole proprietorship is an unincorporated business that you own and run by yourself.<\/p>\n\n\n\n
That word \u201cunincorporated\u201d is important. Since the business is unincorporated, it\u2019s not a separate legal entity from you. If someone sues the business, they\u2019re suing you. And you\u2019ll be personally responsible for the business\u2019s debts too.<\/p>\n\n\n\n
This is one of the simplest business \u201cstructures\u201d because in many ways, it isn\u2019t a business structure at all. It\u2019s just you, doing business under a business name.<\/p>\n\n\n\n
Pros:<\/strong><\/p>\n\n\n\nEasy. A simple option with minimal formalities. <\/p>\n\n\n\n
If you\u2019re going to run the business by yourself and you aren\u2019t concerned about debt or liability, this could be a good way to get started.<\/p>\n\n\n\n
Cons:<\/strong><\/p>\n\n\n\nProvides no personal protection. You\u2019ll be personally liable for business debts as well as any actions your business takes. Not recommended for high-liability industries.<\/p>\n\n\n\n
You can\u2019t sell shares to raise money, and banks are often reluctant to lend money to sole prorprietorships.<\/p>\n\n\n\n
Partnerships<\/h3>\n\n\n\n
Ownership:<\/strong> Two or more owners<\/p>\n\n\n\nSell shares:<\/strong> No<\/p>\n\n\n\nPersonal protection:<\/strong> Yes, although it varies between LPs and LLPs<\/p>\n\n\n\nTaxation:<\/strong> Partners are taxed personally; the company does not pay its own taxes<\/p>\n\n\n\nPartnerships let two or more people own a business together. There are two common kinds: limited partnerships (LP) and limited liability partnerships (LLP).<\/p>\n\n\n\n
In limited partnerships, one \u201cgeneral partner\u201d has unlimited liability while all the other partners enjoy limited liability, but they also have limited control of the company. These limits are usually laid out in a partnership agreement. <\/p>\n\n\n\n
In limited liability partnerships, all partners are treated equally, with limited liability.<\/p>\n\n\n\n
In both cases, profits are passed through to personal tax returns, meaning the partnership itself does not pay taxes. Instead, the taxes are paid by the partners as part of their personal taxes. In limited partnerships, the general partner also has to pay self-employment tax.<\/p>\n\n\n\n
Pros:<\/strong><\/p>\n\n\n\nPartnerships allow you to own a business together. They\u2019re popular among groups of professionals like lawyers, accountants, or consultants who want to pool their resources, sharing the risks and responsibilities of owning a business. <\/p>\n\n\n\n
Cons:<\/strong><\/p>\n\n\n\nMay be limited to certain types of professionals, depending on your state. May be required to file annual reports. Often have more formal obligations for filings and paperwork than LLCs.<\/p>\n\n\n\n
Limited liability company (LLC) <\/h3>\n\n\n\n
Ownership:<\/strong> One or more members<\/p>\n\n\n\nSell shares:<\/strong> No<\/p>\n\n\n\nPersonal protection:<\/strong> Yes, your personal assets are generally protected from business debts and legal liabilities<\/p>\n\n\n\nTaxation:<\/strong> LLC members are taxed personally; the company does not pay its own taxes<\/p>\n\n\n\nA limited liability company (LLC) can be owned by one person (a sole-member LLC) or by two or more people together (a partnership LLC). It provides protection for your personal assets against business lawsuits and creditors.<\/p>\n\n\n\n
Like sole proprietorships and partnerships, LLCs don\u2019t pay taxes as corporate entities. Their profits pass through to the individual members, who pay taxes as part of their personal income taxes. That\u2019s why sole proprietorships, partnerships, and LLCs are sometimes called \u201cpass-through entities.\u201d <\/p>\n\n\n\n
Pros:<\/strong><\/p>\n\n\n\nLLCs offer significant benefits for those who want to enjoy pass-through tax advantages and protection from personal liabilities without the full regulatory burden of corporations. They\u2019re a popular choice among entrepreneurs, freelancers, small business owners, and real estate investors. <\/p>\n\n\n\n
Cons:<\/strong><\/p>\n\n\n\nOne of the biggest trade-offs of choosing an LLC is that you generally can\u2019t sell shares. If you want to raise funds through equity financing or pursuing an IPO, the LLC structure usually won\u2019t let you do that.<\/p>\n\n\n\n
LLC rules, like other business entity rules, also vary by state. Depending on where you live, LLCs may only be allowed for more than one member, may have a limited lifespan, or may be required to dissolve and reform if there\u2019s a change in ownership. <\/p>\n\n\n\n
S Corporation<\/h3>\n\n\n\n
Ownership:<\/strong> 1-100 shareholders<\/p>\n\n\n\nSell shares:<\/strong> Yes<\/p>\n\n\n\nPersonal protection:<\/strong> Yes, your personal assets are generally protected from business debts and legal liabilities<\/p>\n\n\n\nTaxation: <\/strong>Shareholders are taxed personally; the company does not pay its own taxes<\/p>\n\n\n\nAn S Corporation (S Corp) allows for shareholders while still passing income, losses, deductions, and credits through to those shareholders for federal tax purposes. This helps the shareholders avoid double taxation in the same way an LLC does. <\/p>\n\n\n\n
This structure is a good option for small to medium-sized businesses looking to limit their liability and benefit from pass-through taxation while still allowing for the possibility of shareholders. To qualify, a business must have a limited number of shareholders, all of whom must be U.S. citizens or residents.<\/p>\n\n\n\n
Pros:<\/strong><\/p>\n\n\n\nS corporations offer liability protection as well as the tax advantages of a pass-through entity, while also allowing for shares that can be transferred. The S corp structure may also enhance credibility with customers and investors due to its formalized structure.<\/p>\n\n\n\n
Cons: <\/strong><\/p>\n\n\n\nOn the downside, S corps face limitations on the number and type of shareholders, which can restrict fundraising efforts and the potential for growth. There are also stricter operational processes and compliance requirements, such as holding regular meetings and maintaining detailed records. <\/p>\n\n\n\n
Corporation<\/h3>\n\n\n\n
Ownership:<\/strong> Ownership in a corporation is divided into shares held by shareholders<\/p>\n\n\n\nSell shares:<\/strong> Yes<\/p>\n\n\n\nPersonal protection:<\/strong> Provides the strongest shield in protecting personal assets from business liabilities<\/p>\n\n\n\nTaxation: <\/strong>Taxed as separate entities, paying corporate income tax<\/p>\n\n\n\nA corporation is a legal entity that exists independently of its owners. It provides the strongest liability protection for its shareholders, meaning their personal assets are typically protected from the corporation’s debts and liabilities. However, corporations are taxed separately from their owners, leading to the potential for double taxation on income\u2014the corporation pays income tax, and shareholders may also pay personal income tax on their net gains.<\/p>\n\n\n\n
This business structure is suitable for larger businesses or those seeking to raise funds through the sale of stock, as it allows for an unlimited number of shareholders and greater access to investment capital.<\/p>\n\n\n\n
Pros:<\/strong><\/p>\n\n\n\nThis structure offers the strongest liability protection to shareholders, which can encourage investment and limit personal financial risk. Corporations can also raise capital more easily through the sale of stock, they may benefit from a wider range of tax deductions and incentives, and they have perpetual existence, meaning they can continue operating independently of changes in ownership or management.<\/p>\n\n\n\n
Cons: <\/strong><\/p>\n\n\n\nSmall businesses or individual entrepreneurs might face challenges due to complicated regulations, high administrative costs, and the risk of double taxation on earnings when choosing this business structure.<\/p>\n\n\n\n