What Is the Best Business Structure for a Small Business
Business structures got you down? Here's a breakdown of the 5 most common types (sole proprietorship, partnership, LLCs, C-corp, and S-corp) and why you should or shouldn't choose them.
Starting a business can be overwhelming. You're juggling funding, creating a business plan, hiring a team, and building a marketing plan. Even just figuring out what to name your business can take weeks. Then, there's the business structure. What the heck is a business structure? Why does it matter? Oh, and which one is right for your business?
Don't let details like this hold you back. Below, we'll outline the most common business structures, who should use them, and why they might be a good fit for your business.
What is a business structure, and why should I care?
Business structure refers to the legal structure of your company. It impacts ownership, liability, how you process profits and losses, and how much you pay in taxes. Before registering your business with the state, you'll have to figure out the business structure. Applying for licenses? Want to get a bank loan? You'll need to figure out your business structure before you can do any of that fun stuff.
Short disclaimer: we're not business lawyers, and we're definitely not your business lawyer. State laws can impact the exact definition of different business structures and how you pay taxes. We recommend talking to an attorney to make sure you're making the right choice. Don't blame us if you choose the wrong business structure and your late partner's third cousin gets 75% control of your chihuahua dental practice.
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5 common types of business structures and when to use them
So, what is the best business structure for a small business? There's no one right answer. Most small businesses choose an LLC, which protects personal assets and lowers your tax obligation. But it's not the only choice.
Depending on the type of business and your goals, there might be a better option. Here are the most common types of business structures and who should use them.
A sole proprietorship is the simplest business structure. It provides the sole owner (you) with complete control over the entire business. It's also the default business structure—if you don't file any legal paperwork, this is automatically what your business is.
Essentially, there is no separate business structure. You are your business, your business is you—which can get you into hot water. For example, if someone sues you, they can come after your personal assets. If you take out a business loan, the bank can take your house if you don't pay. You also can't sell stock in your business. Profits, losses, and taxes pass through your personal tax returns, and tax write-offs can be limited compared to other business structures. You'll also have to pay self-employment taxes.
A partnership is a legal structure ideal for businesses with multiple owners or professional groups, such as a law or medical practice. There are two main types of partnerships:
- Limited partnership: One main owner has unlimited liability and other partners have limited liability. This means one person retains most of the control (and liability.) Profits pass through a personal tax return and the main owner pays self-employment taxes.
- Limited liability partnership: All owners have limited liability, protecting their personal assets from business liability.
Partnership agreements define the exact terms of your partnership, which also makes this model pretty flexible. Partnerships are a solid choice for businesses with multiple owners, especially in professional services.
A limited liability corporation is the simplest corporate structure. It allows business owners to take advantage of the benefits of a corporation while also protecting personal assets. This means if Susan gets mad about how her kitchen remodel went, she can't sue you and take your Honda Accord.
Profits pass through your personal tax returns, and LLC owners are still considered self-employed, which means you'll be responsible for paying self-employment taxes (the portion of medicare and Social Security that an employer generally covers.)
A C corporation creates a legal entity entirely separate from its owners. C corporations can be taxed, sued, and even put through a criminal court case in some cases. Of course, there are plenty of benefits, namely:
- Protects personal assets of owners
- No self-employment taxes
- Can sell shares to raise funds
One of the main drawbacks of a C corp legal structure is double taxation. In a C Corp, the business pays taxes on its profits—and so do shareholders when dividends are paid out. But, this model also provides more stability if owners sell their shares and leave, for example, the company can keep running. C Corp is a good option for larger businesses with moderate to high risk who want to be able to offer shares or "go public," as the cool kids say.
An S Corp is not like other corporations, it's a cool corporation. Okay, not really, but it does provide some interesting benefits, especially for small businesses. For starters, it avoids the double taxation issue of a C corp by allowing profits and some losses to pass through your personal tax returns. State taxes are generally lower as well, but that can vary by state. However, S Corps are separate entities, which means your personal assets are protected, and you can sell shares.
Not all businesses can file as an S Corp. You'll need to check out the IRS requirements to see if your business qualifies.
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