Which Business Type Is Best for Your Company?

Comparisons of Business Types with Pros and Cons

One of the key decisions in starting a business is deciding which business type to form. You'll get lots of advice from people, but as you sort through it, consider taxation, control, cost, and liability issues.

This article presents features, with pros and cons, of each of the major business types, to help you make the best decision for your new business.

Key Takeaways

  • The two basic business types for tax purposes are corporations and pass-through businesses that file their business taxes with their personal tax returns.

Basic Types of Business Organizations 

Since taxes are a major issue in deciding which business to choose, here's an explanation of the two basic business types for income tax purposes.


A corporation is a business that is separate from its owners, called shareholders, who buy shares of stock in the corporation. These owners receive payments from the business in the form of taxable dividends. Some owners might also be executives or employees, and they're paid as employees for the duties they perform in addition to receiving shareholder dividends.

Pass-Through Businesses

Pass-through businesses are called that because the tax liability of the business are passed through to the owner as part of the owner's personal tax return. For example, if a sole proprietor has a net income of $25,000 for the year on their Schedule C, that amount is added to all the other income of the person (and their spouse, if they have one), along with any business and personal tax credits to calculate the person's total tax liability for the year.

Sole proprietorships, partnerships, limited liability companies (LLCs), and S corporations (a special kind of corporation) are pass-through entities.

Self-Employment Tax and Business Types

Some business owners – sole proprietors, limited liability company (LLC) owners, and partners in partnerships – are considered self-employed, and they must pay self-employment tax (Social Security and Medicare taxes) on the net income from their business. S corporation owners are not considered as being self-employed. You should include self-employment taxes when you look at your tax situation for one of these business types.

Factors to Consider in Selecting a Business Type

  • Startup ease and cost, including legal fees, and cost of operation
  • Ownership control and the tradeoff between control and profits/losses
  • Taxes on the business and how the business or owner pays taxes
  • Liability of business owners for the debt of the business, for actions of other owners for general liability .

Business Types in States 

Corporations, partnerships, and limited liabili must register with a specific state where they plan to do business. Requirements and rules for business structures are set by the states through each state's business division or corporations office. All states allow corporations, partnerships, and LLC's, but some variations on these basic business types might or might not be available. 

Check with your state secretary of state, usually the business division, to get more information on their registration process.

Sole Proprietorships (Sole Props)

A sole proprietorship is a type of business operated by one individual. The business is not considered a separate legal entity from its owner and it doesn't have to register with a state. This feature has pros and cons.

On the pro side, the sole proprietor has full ownership rights in decision-making and doesn't have to answer to a board of directors or other owners. It also means the owner receives all the profits of the business. Taxes are fairly simple, consisting of a Schedule C form included in the owner's personal tax return.

On the con side, it means the owner must take all of the losses of the business. It also means that the owner may be personally liable for the debt of the business, in bankruptcy, for lawsuits against the business, and for general liability purposes.

Sole proprietorships might be a good choice or starting a new business in a low-risk situation before forming a more formal business.

Corporations (C Corps)

An incorporated business is separate from its owners for operations, taxes, and liability purposes. The corporation is formed with Articles of Incorporation under the laws of the state in which it is operating. Corporations are costly to form because, in addition to the state registration, they must have a board of directors, keep regular meeting minutes and other corporate records, and report to shareholders.

The corporation pays its own taxes, and the owners pay taxes on dividends as shareholders, which in some cases may be double taxation.

Board members, officers, and executives have no personal liability for business activities, unless they "pierced the corporate veil" by acting illegally or for personal gain outside the scope of their responsibilities for the company.

A corporation is the most complicated type of business to start and maintain, and they may be double taxed, with but the current corporate tax rate of 21% may be an incentive to incorporate. 

S Corporations (S Corps)

A subchapter S corporation or S corp is a corporation which has the limited liability benefits of a corporation but is taxed as a pass-through business, like a partnership. The S corporation owners aren't double-taxed on their income, but there are several restrictions on electing S corporation status, including a limit of 100 shareholders and only one class of stock.

Taxes are fairly complex for S corporations because they must file a federal tax return return and separate schedules for the tax due from owners and some states also tax S corporations.

Like corporations, S corporations must have a board of directors and follow all the filing and operating procedures of a corporation.

A Subchapter S corporation is not set up by registering with a state. You must first set up a corporation in your state then you can elect S corporation status with the Internal Revenue Service (IRS). This election must be done within a specific time period so check with a tax professional to make sure the election is done correctly. 

Limited Liability Companies (LLCs)

All states give you the ability to set up a limited liability company (LLC) by registering Articles of Organization or a similar document with the state and creating an operating agreement to govern member decisions, including how they share profits and losses of the business. LLC owners are called members, and an LLC may have only one member, called a "single-member LLC."

LLCs are easier to form than corporations, but they have similar protection against liabilities of the company as do corporations.

Another benefit to forming an LLC is that they have several options for taxes, choosing the one most beneficial to the specific situation:

  • A single-member LLC pays taxes as a pass-through entity, with members paying the company's taxes on their personal tax returns
  • A multiple-member LLC usually pays taxes like a partnership
  • And both types of LLCs can elect to be taxed like a corporation or an S corporation.

This article explains the difference between LLCs and partnerships.


Special Tax Status of Single-Member LLCs

A single-member LLC is considered a disregarded entity by the IRS, which means the business is disregarded as separate from the owner but only for tax purposes. The SMLLC owner reports business income and deductions on Schedule C, like a sole proprietor. The disregarded entity designation doesn't affect the owner's limited liability protection. But, for employment tax purposes, and certain excise tax purposes, the single-member LLC is treated like a separate entity. meaning they are liable for collecting these taxes and reporting them to the IRS.


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A partnership is a business with two or more individuals who share the risks and benefits of the business, including the partnership profits and losses. Partnerships are fairly easy to start and operate. They must register with a state and create a partnership agreement. They have some recordkeeping requirements, but not as complicated as a corporation.

A partnership can include two types of partners:

  • General partners who participate in the day-to-day management of the business and have liability for partnership debts and for actions of the partnership 
  • Limited partners who are merely investors and who don't share in the day-to-day operations of the business or in liability

Partnerships pay their business taxes by filing an information return with the IRS to report business tax liability. No tax is paid on this form because of the partners' pass-through status. Instead, the income or loss is divided between the partners according to their agreement. Then, each partner receives a Schedule K-1 form showing their share for the year, reported on the personal tax returns.

There are several types of partnerships to choose from, depending on the amount of liability the partners want to assume:

A general partnership includes general partners who each make business decisions, but each partner has unlimited liability for debts and decisions of other partners.

A limited partnership (sometimes called an "LP") has both general partners, who participae in business decisions, and limited partners, who invest in the business but don't participate in daily operations. General partners have liability for company debts and actions, but limited partners are shielded from liability, as long as they don't become involved with business decision-making.

A partnership is different from a joint venture, which is a kind of partnership between two businesses for a specific purpose. 

Professional Corporations (PCs)

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A professional corporation is a specific type of corporation for professionals such as attorneys, doctors, architects, or accountants. These professionals can form a corporation in some states with the distinction that each professional is still liable for his or her own wrongful professional actions.

Limited Partnerships

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A partnership is sometimes called a "limited partnership" when it has both general partners and limited partners. A limited partnership is an entity distinct from its partners.

As with a partnership, the general partners deal with the day-to-day operations of the business, and they have liability for debts and for actions of the other partners. Limited partners do not participate in the day-to-day operations of the partnership, and they bear no liability for its debts or actions. 

Limited Liability Partnerships (LLPs)

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Limited liability partnerships (LLPs) are formed with general partners but all the general partners are shielded from liability for the acts of the others as well as employees. The LLP is similar to a limited liability company but the LLP operates under partnership rules.

Do You Need an Attorney to Start a Business?

Most states give you the ability to register a business—even a corporation—online but you'll still need startup documents like corporation by-laws, a partnership agreement, or an LLC operating agreement. Even if you register your business yourself, you should still consider getting help from an attorney When it comes time to prepare these documents.

All these business agreements should be reviewed by an attorney to save you from legal hassles and disputes later.