Choosing the Right Business Structure

 

The type of business structure, or business entity, you choose for your business will determine what rules you’ll need to follow when creating and operating your business.

Your business structure also dictates how you’ll pay your taxes and how much you’ll have to pay. In today’s post, I’ll compare and contrast possible business structures to help you make the right choice for you, your business, and your bank account.

Business Structure Options for Business Owners without Partners

If you plan to own and operate a business without a business partner, then you have a few business structures to choose from. The most common are:

In the bulleted lists below you’ll find the information I provide my clients to help them weigh the pros and cons of each of these business entities. You’ll notice that an important factor to consider when choosing a business structure is how much personal liability you’ll want to risk for your business.

Sole Proprietorship

  • Works Best For:
    • Businesses with low risk of liability
    • New, part-time, or seasonal businesses
  • Pros:
    • Easy to create, operate, and close
    • No double taxation
  • Cons:
    • Owner is personally liable for any financial obligations of the business or if the business is sued
    • Self-employment tax applies to all profits
    • Difficult to find investors or get bank loans
    • Difficult to transfer ownership
  • Taxes:
    • File Schedule C attached to personal tax return
    • Owner pays self-employment tax on net profits
    • Losses can offset some other types of income
    • Owner could qualify for 20% qualified business income deduction

Single-Member LLC

  • Works Best For:
    • Businesses with at least some risk of liability
  • Pros:
    • Protects personal assets if business is sued
    • Easy to create, operate, and close
    • No double taxation
  • Cons:
    • Self-employment tax applies to all profits
    • Difficult to transfer ownership
  • Taxes:
    • File Schedule C attached to personal tax return
    • Owner pays self-employment tax on net profits
    • Losses can offset some other types of income
    • Owner could qualify for 20% qualified business income deduction
  • Important Considerations:
    • Must keep personal and business records and money separate

S-Corporation

  • Works Best For:
    • Businesses with substantial risk of liability
  • Pros:
    • Pass-through taxation saves owner money in taxes
    • Protects personal assets of owners and shareholders if business is sued
    • Can sell stocks to attract investors
    • Business remains if owner leaves, retires, or dies
    • No double taxation
    • Easy to transfer ownership
    • Self-employment tax does not apply to all profits
  • Cons:
    • Additional paperwork and fees
    • Can be more difficult to create and operate
  • Taxes:
    • File Form 1120-S
    • Distributions aren’t subject to self-employment tax
    • Losses can offset some other types of income
    • Shareholders could qualify for 20% qualified business income deduction
  • Important Considerations:
    • Owners must pay themselves a reasonable salary and that salary is subject to payroll taxes
    • Must have regular board of directors meetings with recorded minutes
    • Must keep track of S-Corporation basis

C-Corporation

  • Works Best For:
    • Businesses with substantial risk of liability
    • Businesses planned to outlast the owner
    • Businesses with at least one owner who isn’t a U.S. citizen
    • Businesses with more than 100 shareholders
  • Pros:
    • Protects personal assets of owners and shareholders if business is sued
    • Can sell stocks to attract investors
    • Can last forever
    • Easy to transfer ownership
  • Cons:
    • Double taxation
    • Difficult to create and operate
    • More state and federal regulations to follow
  • Taxes:
    • File Form 1120
    • Net profits are taxed at the corporate rate
    • Shareholder dividends are taxed on individual tax return
    • Business losses cannot offset shareholder income
  • Important Considerations:
    • Reasonable wages must be paid
    • Must have regular board of directors and shareholder meetings with recorded minutes

Business Structure Options for Business Owners with Partners

If you’re looking for a business entity that will work best for your business partnership, then the most common types to consider are:

  • General Partnership
  • Multi-Member LLC
  • Limited Liability Partnership

You’ll see in the bulleted lists below that partnerships generally follow the same rules when it comes to taxation, but as is the case when choosing any business structure, you’ll want to determine what amount of liability is acceptable to you and your partner(s). You’ll also want to think about how or why your business may evolve over time and what needs your business might have in the future.

General Partnership

  • Works Best For:
    • Partners or businesses that want to work together as one business or partnership
  • Pros:
    • Easy to create and operate
    • Unlimited number of partners
    • No double taxation
  • Cons:
    • Requires separate tax return
    • Self-employment tax applies to all profits for each partner
    • Difficult to close
    • Hard to transfer ownership
  • Taxes:
    • File Form 1065
    • Each partner pays self-employment tax on their share of profits
    • Losses can offset some other types of income
    • Owner could qualify for 20% qualified business income deduction

Multi-Member LLC

  • Works Best For:
    • Businesses with at least some risk of liability
    • Businesses planned to outlast the members
    • Businesses with expected membership changes
  • Pros:
    • Protects personal assets if business is sued
    • Unlimited number of members
    • Ownership can be transferred more easily than with a single-member LLC
    • No double taxation
  • Cons:
    • Additional paperwork and fees that vary by state
    • Self-employment tax applies to all profits for each member
  • Taxes:
    • File Form 1065
    • Taxed as a partnership unless elected to be a corporation
    • Losses can offset some other types of income
    • Owner could qualify for 20% qualified business income deduction

Limited Liability Partnership

  • Works Best For:
    • Businesses with at least some risk of liability
    • Businesses where not all partners take an active role in the business
  • Pros:
    • Protects personal assets of limited partners if business is sued
    • Ownership can be transferred following the rules of the agreement
    • Limited partners only pay self-employment tax on their guaranteed payments
    • No double taxation
  • Cons:
    • One partner must have unlimited liability
  • Taxes:
    • File Form 1065
    • Limited partners do not pay self-employment tax except with guaranteed payments
    • Losses can offset some other types of income
    • Owner could qualify for 20% qualified business income deduction

Choosing a business entity is a decision that may take you some time. If you need help determining which structure would work best for you, consider consulting a CPA to talk through specifics and help you make the best choice. Here are a few of my other articles to help you get started:

Can My Business Deduct Meals and Entertainment Expenses?

Are Stock Certificates Required for S-Corporations?

 

Amy Northard, CPA

The Accountant for Creatives®
+ taxes + bookkeeping + consulting
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