The 5 Basic Business Structures

If you are getting ready to start a business you may be wondering what business structure is what and which one may be right for you. Below is a brief summary of the five basic business structures and how they operate.

Sole Proprietor

This is the most simple structure used when one individual owns and operates a business. While you won’t have to file any articles of incorporation, you may still have to obtain certain licences and permits to operate. Check with your state and city for specific requirements.This structure is a pass through entity meaning that the business’ income and losses are reported through the individual’s tax return on a form called Schedule C. You will also have to pay 15.3% self-employment taxes on your net earnings. A major downside of a sole proprietorship is that you are personally liable for your businesses liabilities and your personal assets could be seized to fulfill a debt or lawsuit. Some people incorporate as an LLC because of this reason which I will discuss further down.

Partnership

This is a structure used when you have more than one owner of a business. This structure is also a pass through entity where income and losses of the business are passed down to the partners. The business files form 1065 with the IRS to report income and losses and each partner reports their share of income and losses on a Schedule K-1. Like Sole Proprietorships, the partners of a Partnership are also personally liable for any liabilities and may want to incorporate as an LLP where partners are only liable for their own malpractice or an LLC which provides liability protections that corporations receive. Partners also pay self-employment taxes.

S Corporation

An S Corporation is a structure that has more legal requirements and must file articles of incorporation; however, it is still considered a pass through entity. Income and losses are passed down to shareholders and shareholders report net earnings on their tax returns. S Corps benefit from liability protection and avoid the double taxation that happens with C Corporations. Dividends to shareholders are not considered income to the shareholders.

C Corporations

A C Corp is taxed as an independent entity and is not considered a pass through entity. The corporation files a separate tax return and is taxed at a flat 21% federal rate. C Corps must file articles of incorporation and it is a structure that has more legal requirements. Corporations are also double taxed, meaning the corporation pays corporate income tax (state and federal) and shareholders are taxed for any dividends they receive. One benefit of the corporate structure is that owners are not personally liable for the business’ debts.

LLC

An LLC stands for Limited Liability Company and offers business owners liability protection. LLCs are required to file articles of incorporation and may have other legal requirements depending on the state in which you are operating. Like Sole Proprietors, Partnerships, and S Corps, LLCs are pass through entities. If a sole owner forms an LLC, the tax treatment is the same as a sole proprietorship.

And that’s it! A brief overview of the five basic business structures. It’s always a good idea to talk to your accountant about which structure might be the best for you. Several factors could be at play in making the best choice such as the nature of your business, where you do business, and your income tax rate.