Fifth Third Bank's breakdown of sole proprietorships, limited partnerships, and corporations will help you understand the types of business structures.
Choosing a business structure may seem like a simple decision as you begin your adventures in entrepreneurship. However, it pays to spend some time considering which business structure makes sense for your work now—as well as into the future.
There are stark differences between sole proprietorships, LLCs and corporations. Some structures offer less liability protection but keep your taxes simple. Others create a staunch boundary between your personal and company assets but require far more in the realm of tax preparation and work.
Understand the nuances of each to ensure you select a structure that works for your personal and business needs and goals.
This is one of the most common business structures, and probably the simplest to set up and maintain. A sole proprietorship means that you are your business and there’s no other entity to register. As such, your business and personal assets and liabilities are considered the same. The structure offers a lot of simplicity: You consider all the money you bring in as income, and pay taxes on it via your personal return.
However, sole proprietorships do put your personal assets at risk of liability. That means if someone sues your business or creditors want to make a claim, they have access to your personal funds. This structure works the best for people who are either just starting out in their business and perhaps want to see how it goes or someone who anticipates very little risk with their work.
A limited liability partnership or limited partnership is a good choice if you’re going into business with others. The structure limits the liability of the members involved with the business while denoting who is in control of the company. So for example, in a limited partnership, the general partner has unlimited liability, meaning the GP is beholden to the business liabilities of the company. Meanwhile, the structure limits liability to the other company partners.
An LLP limits the liability of all members, and no one is subject to unlimited liability. The primary benefit of the limited partnership structure is that it allows you work together in control of a business, but limits your liability (unless you’re the general partner) to only the capital you’ve invested.
Corporations are a bit more complicated to set up and maintain—but for long-term businesses, the effort may be worth it. First, the structure separates the businesses from its owners, so the corporation becomes its own financial and tax entity. The corporation pays taxes on its business, and the owners receive dividends or earnings and pay taxes on those.
There are specific subtypes of corporations and each has its own differentiators. For example, an S Corp offers the limited liability protection of a corporation, but its income is taxed more like a partnership. The goal is to avoid the double taxation that some owners of corporations face (taxed on business income and taxed on personal income).
C Corps, meanwhile, are the most regulated type of corporation, and they offer the most protection to business owners in terms of liability. This structure allows the company to raise capital and take on shareholders. The latter can come in and out of the company, without impacting the company operations.
Limited Liability Companies
LLCs offer some of the benefits of a corporation, but for tax purposes are treated more like a partnership or a sole proprietorship. The primary difference between the two structures is in the ownership. Corporations are owned by their shareholders; LLCs are owned by individuals. The first owns shares of stock in the business, while LLC owners have an equity stake.
The profits for an LLC pass through to the owners, and they claim the earnings as personal income. (Corporations, remember, remain separate entities and pay their own taxes.) This structure works well for groups or individuals that want to start a business but want to keep the taxes simple. From a liability perspective, LLCs offer more protection than a sole proprietorship.
More than a box to check on a form, your business structure will impact your taxes and personal liability. Consider the pros and cons of each before you choose the one that makes the most sense for your company.