The business structure your company uses will determine how you pay taxes and your day-to-day operations. It can also impact liability, ownership, and distribution payments. By learning more about different types of business structures, you can make sure that your small business chooses the best option for its continued growth. 

The Most Common Business Structures

By the numbers, sole proprietorships are by far the most common business structure in the country. However, there are still millions of S corporations, partnerships, and C corporations as well.

• Sole Proprietorship: 20.3 million 
• S Corporations: 3.65 million
• Partnerships: 2.2 million
• C Corporations: 1.5 million

When you register your company, there are a few common options you can choose from. While it’s possible to change the business structure later on, it’s far easier to pick the right one to start with. Your choice will determine whether you can raise capital, your personal liability for the company’s obligations, and whether profits pass onto the owners or not. Because of this, take time to consider your needs and goals before deciding on a business structure.

Sole Proprietorships

Sole proprietorships are only owned by one person, so they don’t have to pay corporate taxes. Instead, all of the company’s tax liability is reported on the owner’s personal tax return.

Because a sole proprietor isn’t a separate business entity, all of the tax liabilities and debts pass onto the owner. While sole proprietorships are easy to set up, there are limitations to how you may be able to sell stock or apply for loans. However, they can be a good option for a low-risk business or someone who is just testing out a business idea.

Benefits 

• Tax Deductions: Up to 20% of your company’s income can be deducted from your tax return.
• Simplicity: Unlike some business structures, sole proprietorships are relatively easy to form.
• Total Control: A sole proprietorship is solely controlled by you.
• Fewer Regulations: This business structure has relatively few regulations compared to other structures.
• Straightforward Dissolution: If you want to end a sole proprietorship, the dissolution process is easy.
• Privacy: Thanks to its private ownership, sole proprietorships enjoy an excellent level of privacy. 

Drawbacks 

• Unlimited Personal Liability: Because of the lack of liability protections, the owner faces unlimited liability if there is a lawsuit. With a sole proprietorship, you’re on the hook for any debts your business incurs.
• Higher Taxes: In addition to being taxed for any other personal income, the income from your sole proprietorship will also appear on your tax return.
• Lack of Credit and Capital Access: Because of the business structure, your company can’t develop credit on its own. For similar reasons, sole proprietorships have less access to capital.
• Potential Seizure of Personal Assets: If your business gets into debt, creditors can seize your personal assets to repay the debt. 
• Limited Growth: Unless the sole proprietorship is incorporated as a different business structure, it will face fewer growth opportunities.

Partnerships

A partnership typically involves two or more partners who work together to manage the business. This simple business structure is similar to a sole proprietorship. Partners can be general partners or limited partners. A general partner is liable for the company’s liabilities, but a limited partner has limited liabilities in the business.

Because there are no specific requirements about how profits and losses must be distributed, it’s a good idea to create an ownership agreement between partners. Disagreements can occur, so it’s better to clarify the partnership in advance.

Benefits 

• Easy Taxation: Like a sole proprietorship, profits and losses pass along to the owners.
• More Borrowing Opportunities: Because there is more than one owner involved in the business, there may be more borrowing opportunities.
• Lower Financial Burden: In a partnership, you can share the financial costs with your partner instead of having to bear them alone.
• Less Paperwork: Unlike S corporations or C corporations, partnerships require paperwork.
• Increased Knowledge: Because you’re working with someone else, you have more know-how and experience to draw on.

Drawbacks 

• Potential Disagreements: A partnership is owned by more than one person, which increases the likelihood of disagreements.
• Shared Profits: If your business is a success, the profits must be shared among all of the owners.
• Not a Separate Business Entity: As a pass-through business structure, partnerships aren’t a separate business entity. Because of this, the liabilities, debts, and risks pass onto the owners.
• Higher Personal Taxes: All of the taxes are passed through the partnership to the owners’ personal taxes. Because corporation taxes are generally lower than personal taxes, you’ll likely have a higher tax bill than you would otherwise.

S Corporations

S corporations are unique because they allow profits and losses to be passed along to the shareholders like a partnership or sole proprietorship. Unlike a partnership or sole proprietorship, the S corporation has limited liability. There are specific requirements involved in who can own an S corp and the number of shareholders. 

In a recent Mission to Grow interview on “Entity Classification: Exploring the Benefits and Risks of S Corps,” Jason Blumer, CEO of Blummer & Associates, discussed why S corporations are one of the most effective incorporation options for small businesses. “If you are on a mission to grow as an entrepreneur, there are some entities you shouldn’t do that in. An S corp is one you can grow in. It is perfect for small businesses.”

Benefits 

• Cash Accounting: Although S corporations are a type of corporation, the Internal Revenue Service (IRS) still lets them use cash accounting. This simple form of accounting is typically much easier for small businesses to manage.
• Limited Liability: S corporations have more liability protections for owners than sole proprietorships or partnerships.
• No Double Taxation: Because profits and losses pass through to the owners, you don’t have to worry about double taxation.
• Owner Distributions: After owners are paid a reasonable salary, they can receive owner distributions for the remaining profits. These distributions are taxed at a much lower rate than salaries, which means the owner can enjoy having extra take-home pay.
• Credibility: Getting an S corporation set up can help boost your credibility among vendors, employees, and partners.
• Easy Ownership Transfer: If you decide to sell, it’s easier to transfer ownership to a different company.

Drawbacks 

• No Preferred Stock: An S corporation can’t offer preferred stock. The company may only have one class of stock.
• Domestic Owners: S corporations must have domestic owners, so this can limit the ways that you can raise capital.
• Shareholder Maximums: With this type of business structure, you cannot have more than 100 shareholders. 
• Transfer Restrictions: Because S corporations can only have certain owners and shareholders, there are restrictions about who you can transfer shares to.

C Corporations

Unlike an S corporation, a C corporation is taxed at the corporate level. Owners are given the strongest level of protection from personal liability. 

Benefits 

• Liability Protections: Debts are incurred by the organization, and owners aren’t liable for them.
• Perpetual Existence: Even when the founders die, the C corporation can continue to live on because it’s considered its own entity.
• Access to Capital: With a C corporation, you have a lot more options about how you raise capital.
• Multiple Classes of Stock: Unlike an S corporation, a C corporation allows you to sell multiple classes of stock.
• Transfer of Ownership: With a C corporation, ownership can easily be transferred by selling stock.
• Enhanced Credibility: Thanks to your C corporation status, you can enjoy improved credibility among vendors, customers, and investors.

Drawbacks 

• Extra Taxation: C corporations are taxed at the corporate level. Then, any dividends distributed to the shareholders end up getting taxed as well.
• Red Tape: Unlike other business structures, C corporations have a complex business structure. This means there are a lot of forms and red tape involved if you want to set up a C corporation. Once you decide to become a C corporation, you must set up a board of directors, create bylaws, and file your articles of incorporation.

Limited Liability Companies (LLC)

An LLC provides the limited liability that you’d typically get with a corporation as well as the tax benefits of a pass-through entity. They are a popular structure because they combine many of the benefits of a corporation and partnership. 

Even if you have an S corporation or a different business structure, there are times when you may want to use an LLC to hold your assets. According to Blumer, “Typically, you do not put real estate inside of an S corp because a corporate entity is something you can’t really get real estate out of easily if it appreciates because that’s going to be a taxable event. An LLC is typically what people use to hold real estate.”

Benefits 

• Liability Protection: The biggest reason to set up an LLC is for liability protection. If there’s a lawsuit or a debt is incurred, you won’t be personally responsible.
• Asset Protection: LLCs are commonly used to protect assets from lawsuits and creditors. 
• Flexible Taxation: You can be taxed like an S corporation or a C corporation. The LLC is taxed based on your IRS tax election.
• Ownership Options: An LLC has more ownership flexibility than other business structures.
• Profit Distributions: With an LLC, you have more options about how profits are distributed.

Drawbacks 

• Cost: An LLC typically costs more to form than an S corporation or sole proprietorship.
• Automatic Dissolution: While the LLC might not automatically dissolve when a member leaves, this may happen if you don’t transfer ownership properly or your state has specific laws about LLC dissolution.
• Compliance: LLCs must keep beneficial ownership reports and maintain other records. Additionally, there are filing requirements that must be met.

Get Help With Payroll and HR Compliance at Your Small Business 

By learning about the advantages and disadvantages of different business types, you can choose the right structure for your business. Some business structures are better suited to long-term growth, asset protection, and taxation avoidance than other structures.

If you’re ready to catalyze your company’s growth, we can help. For more information about the best business structure for your organization, reach out to our team of small business payroll and HR experts today.