Starting a Business? Which Structure Is Right for You?

Selecting the appropriate structure for your business is one of the most important decisions that you will make, and will have long-term future implications for your company. When considering which structure is right for your particular business, you must not only consider your current business dealings, but also your potential and/or expected growth as well. The business structure you choose will affect your level of control within the company, the size and nature of your business, vulnerability to lawsuits, tax implications, projected profit, whether you will need to reinvest earnings into your business, and ability to access cash from your business’ earnings. While it is possible to change your business structure after it has been established, it can sometimes be difficult depending on your current business structure, and the new structure you want to establish. Read further to learn what implications each structure can have on your business.

Partnership
A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.

Instead of paying an income tax, any profits or losses made by the partnership are passed on to the partners. Those shares and losses are then reported on each partners’ personal tax return. No Form W-2 should be issued for the partners, as they are not employees, but rather a Form 1065, also known as Schedule K-1, should be provided.

Some advantages of a partnership include the following:
• Relatively easy to establish
• Business profits filed on personal tax returns
• Ability to become a partner can attract potential employees

Some disadvantages of a partnership include the following:
• Individual partners can be held liable for the actions of other partners.
• Profits must be shared with others, as well as decision-making responsibilities.
• A partnership can easily come to an end in the event of withdrawal or death of a partner.

Limited Liability Company
Also known as “check-the-box” taxation, limited liability companies (LLCs) are designed to provide the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. Formation is more complex and formal than that of a general partnership.

LLCs are typically taxed as partnerships, but if there are more than two of the four following characteristics, corporation forms must be used:
• Limited liability to the extent of assets
• Continuity of life
• Centralization of management
• Free transferability of ownership interests

C Corporation
In forming a corporation, prospective shareholders exchange money, property or both, for the corporation's capital stock, according to the IRS. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions. For federal income tax purposes, a C corporation is recognized as a separate tax-paying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders. The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends—a double tax.
Advantages of a corporation include the following:
• Shareholders have limited liability for the corporation's debts or judgments against the corporation.
• Shareholders are generally only held accountable for their investment in stock of the company, with the exception of an officer in certain cases.
• Stock represents another possible avenue for income.
• A corporation may deduct the cost of benefits it provides to officers and employees.
• If certain requirements are met, a corporation can be taxed as an S corporation, which enables the company to be taxed similar to a partnership.

Disadvantages of a corporation include the following:
• The process of incorporation requires more time and money than other forms of organization.
• They are highly monitored by federal, state and some local agencies—which means more paperwork and regulations to comply with.
• High taxes.

S Corporation
An S corporation is simply a tax election for a corporation, which enables eligible corporations to avoid being taxed twice, as previously discussed. Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive income. On their tax returns, the S corporation's shareholders include their share of the corporation's separately stated items of income, deduction, loss and credit, and their share of non-separately stated income or loss.

Sole Proprietorship
A sole proprietor is someone who owns an unincorporated business by him or herself. A sole member of an LLC cannot be considered a sole proprietor if the LLC is treated as a corporation, as previously discussed.

Advantages of a sole proprietorship include the following:
• It is the easiest and least expensive form of ownership.
• Sole proprietors have complete control of any lawful decisions they wish to make in regards to the company.
• All business-generated income can be kept, with the exception of taxes.
• Earnings are easily filed on personal tax returns.
• If the business is no longer desired, it is easy to dissolve.

Disadvantages of a sole proprietorship include the following:
• Sole proprietors have unlimited liability and are legally responsible for all debts against the business, and there is no clear distinction between personal and business assets.
• It may be less attractive to potential employees who want to own a part of the business.
• Employee benefits are not directly deductible for tax purposes.