Types of Business Formations

Various Types of Business Formations:

What is an LLC?

A limited liability company, commonly called an LLC, is a popular business structure because it combines the benefits of multiple business types into one. LLCs have the tax advantages of a sole proprietorship or general partnership while also providing the personal liability protection of a corporation. For a more detailed answer, see our definition page.

LLC formation benefits

An LLC is a separate legal entity, meaning that it and the owners (who are called “members” in an LLC) are not the same in the eyes of the law. If the LLC is sued or goes into debt, the members’ personal assets (savings, home, cars, etc.) are usually not at risk.

As with a corporation, forming an LLC does require you to pay a fee and file paperwork with the state, but the management of an LLC allows for much more flexibility than a corporation with less paperwork and fewer reporting requirements. LLC members can draft an LLC operating agreement to customize the rules for managing the company.

LLCs also have tax advantages. By default, LLCs are taxed like sole proprietorships or general partnerships. This usually means that profits are not taxed at the business level before being distributed to the members, who only pay income tax from their share of the LLC’s profits on their personal tax returns. More than 90% of our customers choose to form LLCs when they purchase one of our business formation plans.

What is a C corporation?

The default form of corporation is a C corporation. Like an LLC, a corporation is a separate legal entity from its owners, who are called shareholders. The corporate structure shields the shareholders’ personal assets from the liability and debts of the business.

One disadvantage for C corporations is what’s known as “double taxation.” When a C corporation makes a profit, that income is taxed at the corporate level. Then, when the profits are distributed to the shareholders, they’re taxed again, this time on the shareholders’ personal tax returns.

Benefits of a corporation

The structure of a corporation is also more rigid. Shareholders must elect a board of directors to oversee the management of the business. In turn, the board of directors must ensure that the decisions made benefit the corporation and the vision of the shareholders. Corporations also have more complex reporting requirements and other paperwork. Decision-making can also be a slower process due to the numerous people involved with a board of directors.

Because ownership in a corporation is divided into shares, transferring ownership is actually easier than it is for other business structures, such as an LLC or partnership.

As with LLCs, we can help you navigate the corporation formation process with our business formation plans.

What is an S corporation?

An S corporation is not really a separate kind of business structure, but a tax election status. A C corporation or an LLC can apply for S corporation status with the IRS. S corporation status is often a way for C corporations to avoid double taxation because they’re taxed like a general partnership or sole proprietorship.

Benefits of electing S Corp status

One reason an LLC might opt for S corporation status is that it can save the owners money on self-employment taxes by splitting income into two groups, salary and distribution. The IRS only requires you to pay the 15.3% self-employment on your salary and take the remainder as a distribution not subject to self-employment tax.

S Corp restrictions

S corporations do have some restrictions, though. An LLC or C corporation can file to become an S corporation only if they meet the following conditions:

There can be only one class of stock.
All owners must be U.S. citizens or resident aliens. In addition to individuals, the IRS will also accept “certain trusts and estates” as owners.
There must be fewer than 100 owners.

The tax issues around S corporations can get complicated, so it’s wise to consult a qualified tax professional for guidance.

What is a sole proprietorship?

A sole proprietorship may be the simplest type of business you can create; you’re not required to file any paperwork with the state to be a sole proprietor. With a sole proprietorship, a single person writes the business plan and then forms, owns, manages, and controls the business. This means that all profits come directly to you, but you’re also responsible for all losses.

Benefits of a sole proprietorship

Advantages of a sole proprietorship include easy management, simple decision-making, and flexibility. Disadvantages include unlimited liability if the business is sued or has financial problems.

What is a general partnership?

A general partnership is a company that is owned by two or more people. With this type of business structure, the partners all contribute funds to start the company, and everyone is responsible for its management. Sometimes, partners work out a partnership agreement where each person assumes specific roles within the company.

Benefits of a general partnership

General partnerships are easy to start; they usually require no paperwork to be filed with the state. They often require less capital because multiple people contribute to the start-up costs. As with sole proprietorships, general partnerships involve unlimited liability for business debts. Sometimes, partnerships also run into trouble if partners don’t work together effectively. Learn how to form a general partnership.

What is a nonprofit corporation?

A nonprofit corporation is an entity formed to benefit the public in some way. Private and community foundations can both fall under the nonprofit umbrella. Nonprofit corporations can be exempt from federal income tax, but only if they successfully apply for 501(c)(3) status with the IRS.

Benefits of a Nonprofit Corporation

The tax-exempt status of nonprofit corporations is a distinct advantage of this type of business structure, and the founders and directors of nonprofit corporations also enjoy limited liability for business debts. Drawbacks include the large amount of paperwork necessary to launch and operate a nonprofit as well as high costs and ongoing public scrutiny regarding finances and expenditures.

Choosing a Business Formation Type

The right business structure depends on your specific needs, circumstances, and plans for your business. Here are some considerations to guide your decision:

Liability: If you want to protect your personal assets from business debts and lawsuits, structures like LLCs and corporations offer limited liability protection.
Tax Implications: Different structures have different tax rules. While sole proprietorships and partnerships involve simpler tax preparation, corporations and LLCs can offer greater tax benefits. An S Corporation, for example, allows for pass-through taxation which can be beneficial to avoid double taxation.
Investor Appeal: If you plan on seeking investors or selling stocks, a corporate structure might be your best bet.
Administrative Complexity: Some structures require more paperwork and formalities than others. A sole proprietorship is the simplest, whereas a corporation requires regular meetings, annual reports, and more.
Control: If you prefer complete control over your business, a sole proprietorship or single-member LLC might be the way to go. Partnerships and corporations involve shared control and decision-making.