One of the most important decisions you’ll make when starting a business is choosing the right business structure. The structure you select will affect everything from your legal liabilities and taxes to your ability to raise funds and your day-to-day operations. In this blog, we’ll break down the most common business structures—Sole Proprietorship, Partnership, Limited Liability Company (LLC), C Corporation (C-Corp), and S Corporation (S-Corp)—to help you understand the key differences and choose the best fit for your business.
While S corporations are also common among entrepreneurs, LLCs are generally considered the most popular choice for new businesses.
Sole Proprietorship
A sole proprietorship is the simplest and most common business structure for individuals who are just starting out. If you operate your business by yourself without forming a separate legal entity, you are considered a sole proprietor.
Key Features:
- Ownership: One individual owns and operates the business.
- Liability: There is no legal separation between the owner and the business, meaning the owner is personally responsible for all debts, liabilities, and legal obligations.
- Taxes: Income and expenses from the business are reported on the owner’s personal tax return. The business’s profits are taxed at the owner’s individual tax rate.
- Formation and Compliance: No formal paperwork is needed to establish a sole proprietorship, making it easy and inexpensive to start. However, depending on the industry, you may need specific licenses or permits.
Pros:
- Simple to set up and operate.
- Complete control over the business.
- No separate tax filing for the business.
Cons:
- Unlimited personal liability for business debts.
- Can be harder to raise capital or attract investors.
- Growth can be limited by the owner’s personal resources.
Partnership
A partnership is a business structure where two or more individuals share ownership and responsibility for the business. There are two main types of partnerships: General Partnerships (GP) and Limited Partnerships (LP).
Key Features:
- Ownership: In a general partnership, partners share the business’s management, profits, and liabilities equally. In a limited partnership, at least one partner has unlimited liability (general partner), while other partners (limited partners) have limited liability but do not participate in day-to-day operations.
- Liability: General partners are personally liable for the business’s debts and obligations. Limited partners have liability only up to their investment.
- Taxes: Like a sole proprietorship, a partnership’s profits and losses “pass through” to the partners and are reported on their individual tax returns. The partnership itself does not pay taxes.
Pros:
- Shared financial commitment and expertise among partners.
- Pass-through taxation, avoiding the double taxation seen in corporations.
- Relatively easy to set up compared to corporations.
Cons:
- General partners face unlimited personal liability.
- Disagreements between partners can disrupt business.
- Profits must be shared between partners, which could limit personal earnings.
Limited Liability Company (LLC)
An LLC is a hybrid structure that combines elements of partnerships and corporations. It offers the personal liability protection of a corporation with the tax benefits and flexibility of a partnership or sole proprietorship.
Key Features:
- Ownership: The owners of an LLC are called members, and an LLC can have one or multiple members.
- Liability: Members are not personally liable for the company’s debts or legal obligations. Their liability is limited to their investment in the business.
- Taxes: By default, an LLC is treated as a “pass-through” entity, meaning the profits and losses pass through to the members’ personal tax returns. However, LLCs can also choose to be taxed as a C-Corp or S-Corp.
- Formation and Compliance: Setting up an LLC requires filing Articles of Organization with the state, along with paying any associated fees and ongoing compliance requirements.
Pros:
- Limited personal liability for members.
- Pass-through taxation by default, avoiding double taxation.
- Flexible management structure—members can manage the LLC, or they can hire managers.
Cons:
- More complex and expensive to set up than sole proprietorships or partnerships.
- Some states impose additional taxes or fees on LLCs (e.g., franchise taxes or LLC annual fees).
- Can be harder to attract outside investors compared to a corporation.
C Corporation (C-Corp)
A C-Corporation is a separate legal entity formed under state law, which means it can enter contracts, incur debts, and be sued independently of its owners (shareholders). It is the most formal business structure and is typically used by larger businesses.
Key Features:
- Ownership: Owned by shareholders, who elect a board of directors to oversee the company and officers to manage daily operations.
- Liability: Shareholders have limited liability—personal assets are protected.
- Taxes: C-Corps are subject to double taxation. The corporation pays corporate income tax on its profits, and shareholders pay personal income tax on any dividends they receive.
- Formation and Compliance: Setting up a C-Corp involves significant legal requirements, including filing Articles of Incorporation, creating bylaws, and holding annual meetings. There are ongoing compliance and reporting obligations as well.
Pros:
- Limited liability for shareholders.
- Unlimited growth potential—C-Corps can issue shares to raise capital, making it easier to attract investors.
- Perpetual existence—the corporation continues to exist even if ownership changes.
Cons:
- Double taxation of profits (corporation and dividends).
- More complex and costly to set up and maintain.
- Strict formalities and ongoing regulatory requirements.
S Corporation (S-Corp)
An S-Corporation is a special type of corporation that allows profits (and some losses) to pass through directly to the owners’ personal income without being subject to corporate tax rates, similar to an LLC or partnership. However, it must meet certain IRS requirements to qualify for S-Corp status.
Key Features:
- Ownership: S-Corps can have up to 100 shareholders, and all must be U.S. citizens or residents. It cannot be owned by another corporation or LLC.
- Liability: Shareholders have limited liability protection.
- Taxes: S-Corps avoid double taxation. Profits and losses are passed through to shareholders, who report them on their personal tax returns.
- Formation and Compliance: Similar to a C-Corp, but the corporation must file IRS Form 2553 to elect S-Corp status. The same formalities of a C-Corp apply, such as holding meetings and filing reports.
Pros:
- Avoids double taxation—profits are passed through to shareholders.
- Limited liability protection for shareholders.
- Allows salary and dividend split, which can result in tax savings for owners.
Cons:
- Strict eligibility requirements (e.g., limited number of shareholders, U.S. citizenship).
- More administrative than an LLC or partnership.
- Complicated tax rules—especially related to the reasonable compensation rule for owners.
Choosing the Right Structure for Your Business
Choosing the right business structure depends on various factors such as your industry, goals, risk tolerance, and long-term plans. Here are some points to consider:
- Liability Protection: If protecting your personal assets from business liabilities is important, consider an LLC, S-Corp, or C-Corp.
- Taxes: If you want to avoid double taxation, a pass-through entity like an LLC, S-Corp, or partnership might be ideal.
- Administrative Requirements: A sole proprietorship or partnership is easier and cheaper to set up, while LLCs and corporations require more paperwork and ongoing compliance.
- Growth Potential: If you plan to raise capital or bring on investors, a C-Corp might be the best choice because of its ability to issue stock.
- Ownership Flexibility: S-Corps and partnerships have ownership restrictions, while LLCs and C-Corps offer more flexibility.
No single structure is right for everyone, and each option comes with its own advantages and challenges. It’s important to assess your business’s specific needs and, when in doubt, consult with a legal or financial advisor who can guide you toward the structure that best aligns with your goals.
At Fundamental Gain, we specialize in helping entrepreneurs and small business owners navigate the complexities of setting up and managing their business structures. Let us guide you through the process, so you can focus on what you do best—growing your business.