When you choose a business structure, the most important thing to think about is whether you need limited liability protection. Limited liability protects your personal assets if your business is sued.
Any business that is more than a hobby needs liability protection and starting an LLC is the easiest and least expensive way to get it.
Formal business structures like LLCs and corporations offer liability protection because the business is legally separated from its owner. But only businesses that need outside investors should form a corporation.
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Informal business structures like sole proprietorships and partnerships don't offer protection because there isn't any separation between the business and the owner. Therefore, the owner's personal assets are completely exposed to creditors and lawsuits.
Sole proprietorship. A business owned by an individual that isn't formally organized. A sole proprietor files taxes under his or her own name and is personally liable for any actions taken against the business. General partnership. A business owned by more than one individual that isn't formally organized. A general partnership files taxes under the partners' names and the partners are liable for any actions taken against the business.
The biggest advantage of starting a sole proprietorship or partnership is simplicity; it couldn't be any easier or less expensive to get a business up and running.
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Limited Liability Company (LLC). An LLC is a formal legal business structure that is owned by its members. An LLC is the simplest way of structuring your business to protect your personal assets in the event your business suffers a loss. LLCs also offer unique tax benefits. Corporation. A corporation is a formal legal business structure that is owned by shareholders. A corporation offers personal liability protection and is more complex to maintain than an LLC. Setting up a corporation is most helpful when you need to attract outside investors.
The only disadvantages of forming a formal legal structure are cost and maintenance. For a profitable business, these disadvantages are outweighed by financial and legal advantages.
Personal liability protection is the primary factor to consider when choosing a business structure. Luckily, it's fairly simple to tell if you need it.
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If your business faces liability or risk, or uses business credit, you must have personal liability protection. How to Form a Sole Proprietorship or Partnership
If you don't expect to earn much of a profit or be held liable for an injury etc., you can form your business simply by operating it. In most states, a sole proprietorship doesn't require any type of registration with the government.
Some states require general partnerships to register their business names. To research whether this applies in your state, visit our How to File a DBA guide and choose your state from the drop-down.
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If you expect to earn a profit or if there is any potential risk in operating your business, you must operate under a formal legal structure to protect your personal assets.
Next, we will guide you through choosing between an LLC vs a corporation. Then, we will discuss when it makes sense to opt for the S corp tax designation.
Visit our Form an LLC guide for simple step-by-step instructions for forming your LLC. You can also hire an LLC formation service to set up your LLC (for an additional small fee).
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Most small businesses benefit the most by forming a limited liability company (LLC) vs a corporation. This is because corporations are hard to maintain and most small businesses don't carry over enough profit each year for it to make sense to pay high corporate taxes.
If you expect to reinvest most of the profit back into your small business and you don't need to attract investors, it would make sense to form an LLC.
Small businesses usually carry very little profit from one tax year to the next. This is because small businesses often spend most of their income on expenses to help the business grow.
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LLCs can also elect the S corporation tax classification. This option is for LLCs that generate enough profit to pay it's owner(s) a reasonable salary and regular yearly distributions of about $10, 000 or more.
Pass-through taxation means the net income (profit minus expenses) of the business passes through to the LLC member(s) individual tax returns. This means the business itself will not be taxed and you will only be subject to income tax on the business's net income. Distributions are subject to both income tax and FICA taxes.
A corporation's net income is taxed once on the corporate level at 21%. If any of that profit is paid as dividends to shareholders, they pay income tax and FICA taxes on the dividend as well.
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If you anticipate earning a substantial profit each year and don't need to attract investors, then an LLC that is taxed S corporation would make the most sense for your business. We will cover this topic in detail in the last section of this guide.
Limited liability companies (LLC) are a simple business structure: they require less paperwork, less administrative overhead, and are much easier to start and maintain than a corporation.
LLCs are also adaptable and can elect to become corporations at a later date. This makes LLCs a great starting point for your business to grow.
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If a small business is unable to spend a significant amount of its profit during a tax year on expenses to grow the business, it could make sense to structure the business as a corporation rather than an LLC. This is because of the difference in the way the two business entities are taxed.
A corporation is taxed at about 15% for all profits that carry over to the next tax year. In this same scenario, an LLC member's tax burden would be greater because they pay FICA taxes and federal and state income taxes, which are higher than the 15% corporate rate.
That said, a business owner who anticipates needing to carry profit into the next tax year should look closely at the financial benefits of forming a corporation.
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An investor in a corporation pays taxes on dividends only when they receive them whereas an investor in an LLC would have to pay taxes regardless of whether they received a distribution or not. The LLC investor might never see a return on their investment but might have to pay taxes every year regardless. This is why investors prefer C corps.
If the benefits of managing a complex business structure outweigh the costs, starting a corporation could make sense for your small business.
Corporations are more complex organizations compared to LLCs, with increased administrative overhead, more paperwork, and complex compliance requirements. Managing a corporation may require help from an attorney or accountant which can increase overall business costs.
What Is The Best Business Structure For A Small Business?
Most small business owners choose to form an LLC rather than a corporation. Follow the steps below to get started with the best option for your business.
If your business will benefit most from a corporate structure, visit our How to Start a Corporation page and select your state from the drop-down menu. We provide easy to follow steps for starting (and running) a corporation yourself.
Small businesses often benefit most from forming an LLC vs a corporation. We offer easy to follow guides for starting an LLC in every state. Visit our How to Form an LLC page and select your state from the drop-down menu to get started today.
What Organizational Structure Is The Best Choice For My Business?
Most small businesses file taxes under the default LLC tax classification. This is because small businesses don't usually generate (or net) the amount of profit that would make the S corp tax designation beneficial.
Under an S corp, business owner(s) can save about 17 percent on the distribution portion of their income if the following statements are true:
The S corp tax classification allows business owners to be taxed as employees of an LLC. Under an S corp, the LLC business owner pays FICA (Medicare and Social Security Tax) and federal income tax on only their salary. Distributions are then only subject to income tax.
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Against this savings, you have to balance the time and costs of running payroll and tax withholding. To learn more about what this will cost, get a free tax consultation.
Many LLCs will benefit most from the default LLC tax classification. LLC owners often put any profit right back into their small businesses each year to promote growth. And without profit and distributions, there's no basis for electing an S corp.
Default LLC Tax Benefit: Business owners can choose to invest as much of the businesses profit as they see fit in any given tax year.
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S Corp Tax Benefit: When a reasonable salary is present, the owner pays FICA and income taxes on salary only. LLC distributions are then only subject to income taxes.
The steps to starting a business vary depending on the type of business you plan to start and the state in which it will operate. You can find detailed information in our How to Start a Business, How to Start a Corporation, and How to Form an LLC guides. Simply select your state from the drop-down menu to see its specific steps and requirements.
Several additional types exist within these main groups, such as nonprofit corporations, benefit corporations, single-member, and multi-member LLCs, limited partnerships, general partnerships, and more.
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Yes. The process for changing your business structure varies depending on the type of change and the state in which your business is located.
An informal business structure is a category that includes sole proprietorships and general partnerships. In
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