In terms of business structure, there are several forms to choose from: a sole proprietorship, a partnership, a corporation, and a Limited Liability Company (LLC). When deciding which legal structure is best for a particular business, a business owner should be familiar with the main characteristics of each structure and be able to do a comparison.
The sole proprietorship is the simplest business structure and the least expensive to form. It is generally owned by either one person acting alone or a married couple. All the assets of the sole proprietorship belong to the owner as well as any profits that the business generates. When it comes to paying taxes, the sole proprietor is only required to file an individual tax return and on it list the business’ profits and losses.
One of the biggest disadvantages to the sole proprietorship is that the sole proprietor has unlimited liability and is held legally responsible for all debts against the business. This means that both the business and personal assets of the sole proprietor are at risk.
A general partnership made up of at least two people. Like the sole proprietorship, partnerships are inexpensive to form, but they require an agreement between all the partners involved that outlines how they will own and operate the business. In most cases, the profit and loss as well as the management responsibilities are shared among the partners, and each partner is held personally liable for partnership debts. Unlike the sole-proprietorship, a partnership files a separate tax return. The individual partners also report their share of profits and losses on their personal returns.
The C corporation is the most common business structure among mid-sized and big companies. Of all the business structures, the process of incorporating a business requires the most time and money. A corporation is also subject to more licensing fees and government regulation.
The owners of a corporation are its shareholders. The shareholders in turn elect a board of directors to oversee the business. With a corporation, the net business income is subject to corporate income tax. When funds are distributed as dividends to its stockholders, the money is again taxed (a process called double taxation). Unlike the sole proprietorship and the partnership, a corporation is a legal entity separate from its owners. This means that shareholders have limited liability for the corporation’s debts.
The S corporation is a subcategory of the corporate business structure. Like the C Corporation, the business is owned by its shareholders, but in this case the number of shareholders is limited. The S corporation also provides a limited liability situation for its owners. The major difference between the S corporation and the C corporation is that in the former case, the business is taxed much like a partnership. This means that the income passes through to shareholders who then report it on their individual returns.
Limited Liability Company
A LLC is a relatively new business structure that combines the limited liability of a corporation with the tax advantages and flexibility of a partnership. It is generally considered a good choice for small businesses. LLCs do not have stock, and owners are considered to be in a self-employed status. Income can either pass directly through to the owners, or the members of the LLC can elect to be taxed like a corporation.
In closing, every business structure has its own set of pros and cons. Business owners should enlist the help of a professional accountant or attorney to make the comparison and choose the structure most suitable for their situation.