Which Business Type Is Best for Your Company?
Each type serves a special purpose or concern
Which business type is best? Each type serves a specific purpose, situation, or concern relating to taxes, liability, your control of management, and how you receive profits and losses.
Three Basic Types of Business Organizations
There are three basic types of business organizations.
A corporation is a business that is separate from its owners. The owners are its shareholders. 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. An S corporation is a specific type of corporation, formed by electing S corporation status after the corporation is formed.
Multiple-owner businesses are owned by several individuals. They include partnerships and limited liability companies. The owners share in the profits and losses of the business.
A single-owner business is owned and operated by just one person. This type of business also includes the single-owner LLC business. A sole proprietor business doesn't have to be registered with the state.
Four Factors to Consider in Selecting a Business Type
- Startup ease and cost. How much does it cost to start the business? How is the business registered?
- Ownership control and how the owner gets money from the business are different for each business type.
- Taxes on the business and how the business or owner pays taxes are important considerations.
- Liability for debt, for actions of the owners and employees, and for general liability is also important. Most businesses want to limit their liability as much as possible.
Which Business Type in Which State?
Requirements and rules for business structures are set at the state level through each state's business division or corporations office. Some states allow just certain types of businesses, and many have different regulations and limitations on which business type can be established there. All states allow corporations, partnerships, and LLC's, but some variations on these basic business types might or might not be available.
TIP: Check with your state secretary of state, business division to be sure of the rules in your location, keeping in mind that some states use different terms for this department. You might also check with the business division or another similar department to see if the type of business you want to form is available there.
A sole proprietorship is a type of business operated by one individual. The business is not considered a separate legal entity from its owner, which means that the owner may be personally liable for the debt of the business Its profits and losses are included on the individual's personal tax return, and the owner has personal liability for business debts and lawsuits.
If you want to start a sole proprietorship, you can basically just get a business bank account and start accepting money from customers.
An incorporated business is separate from its owners. The corporation is formed with Articles of Incorporation under the laws of the state in which it is operating.
The corporation pays its own taxes, and the owners pay taxes on dividends as shareholders, Since the business is separate from the owners, the owners have no personal liability.
A corporation is the most complicated type of business to start and maintain, but the current corporate tax rate of 21% may be an incentive to incorporate.
A subchapter S corporation or S corp is a corporation which has the limited liability benefits of a corporation but is taxed like a partnership. Business income or losses flow through to the individual shareholders.
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. This election must be done within a specific time period so check with a tax professional to make sure the election is done correctly.
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.
An LLC is not a corporation, but it has the liability protection of a corporation and other benefits as well, such as ease of formation.
- A single-member LLC pays taxes like a sole proprietorship (See the listing for Single-member LLCs below for more details.)
- A multiple-member LLC pays taxes like a partnership.
- You can even have an LLC that's taxed like a corporation or an S corporation.
This article explains the difference between LLCs and partnerships.
A single-member LLC (SMLLC) is unique because it has the same ownership type and liability protection as an LLC, but it's taxed like a sole proprietorship.
An SMLLC is considered a disregarded entity for tax purposes, which means the business is disregarded as separate from the owner but only for tax purposes. At tax time, 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.
An SMLLC is registered with a state as an LLC. There's no special registration for this business, and the limited liability is the same. Then the owner creates an operating agreement like other LLCs.
An SMLLC can also choose to be taxed as a corporation or S corporation.
A partnership is a business with two or more individuals who share the risks and benefits of the business. A partnership can include two types of partners:
General partners who bear liability for partnership debts and for actions of the partnership, and
Limited partners who are merely investors and who don't share in the day-to-day operations of the business or in liability.
You can sometimes also form a specific type of partnership depending on the regulations of your state. These can include general partnerships, limited partnerships, and limited liability partnerships.
A partnership is different from a joint venture, which is a kind of partnership between two businesses for a specific purpose.
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.
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) 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.
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.