Determining how to structure a new business can seem daunting when considering a startup company, and is one of the most important decisions you make. Careful consideration of which structure is right for you is crucial because it will have many implications, including how the IRS taxes your business profits, whether your personal property is protected when others demand money from your business, and several other considerations.
There are 5 common models of Business Structures:
A Sole Proprietorship is a business that is owned by one person who reports business profits on his or her individual tax return. A Sole Proprietorship is the simplest business structure and is straightforward to start. However, business liabilities can jeopardize the sanctity of the owner’s personal assets with this model.
A Partnership is a business owned by multiple persons, which may be individuals or other businesses. Profits are divided among its owners and reported on their separate tax returns. Common partnership types include general partnerships, limited partnerships, limited liability partnerships (LLPs) and limited liability limited partnerships (LLLPs).
A Limited Liability Company (LLC) is a hybrid business structure that limits the personal liability of its owners, called Members, but allows the profits to be taxed on either a Member level or on the Corporate level. Where multiple functions of the business exist, or multiple properties, a Series LLC may be advisable.
A C-Corporation is a business whose profit is taxed once on the corporate level and a second time on an individual basis when earnings are distributed to its owners, called Shareholders, who have limited liability for the business’s debts. C-Corporations can have multiple classes of stock and an unlimited number of shareholders.
An S-Corporation has one class of stock and no more than 100 shareholders, none of whom can be another for-profit business or a person without a green card who doesn’t meet IRS residency requirements. Profits are taxed on shareholders’ tax returns, and shareholders have limited liability for business debts here also.
So how do you decide which structure will be best for your business?
Consider the following:
- What’s your tolerance for risk to personal assets?
When you run a business, you’re at greater risk for a lawsuit. Why? Businesses interact with the world – other businesses, government, regular people – much more than most individuals, and when they do, there’s a good chance money’s involved. In a sole proprietorship, if your business is sued and loses, your personal assets – real estate, cars, financial accounts – can be targets for the parties seeking to collect damages. The same can be said, in some cases, if you default on a business loan and you signed a personal guarantee, or the lender has placed a lien on your assets. The lender can attempt to recover its investment from your personal property.
- How do you want the IRS to tax your business profits?
Sole proprietorships, partnerships and S-corporations are pass-through entities, as are some LLC’s. In a pass-through entity, profits are passed directly to the owners of the business. Come tax time, it is reported on the owners’ individual returns. By default, the IRS views LLC’s as disregarded entities unless they opt to be taxed like a corporation.
- How formal do you want your management structure to be?
If multiple owners are involved, structuring the business can be more complicated. Partnerships are typically governed by agreements that specify how profits from the business are divided among the partners and what happens when a partner retires, becomes disabled, declares bankruptcy or dies. An S-corporation or C-corporation is required by law to have a Board of Directors to oversee the company’s direction on behalf of its Shareholders. An LLC structure generally allows the choice between being managed by Members or overseen by a Managing Member. Whether an LLC or a Series LLC, an Operating Agreement signed by all Members is required in order to define management, ownership percentages, capital contributions, and more.
- What are your long-term goals for the business?
The right structure depends on the state of your business today, as well as where you would like it to be in the future.