One of the first steps to take when starting a business is to select a legal structure (also known as a business entity). There are four primary types of legal structures (sole proprietorship, partnership, corporation and LLC) to choose from and each has pros and cons.
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Learn more about each type of business entity to help decide what’s best for you:
Sole Proprietorships
- Easiest of the four entities to form and run.
- No formal entity filing – the owner and business are legally the same.
- Most states require a sole proprietorship operating under a business name to file a fictitious name/assumed name/doing business as or DBA with the county where the business is located.
- If the business is sued, the owner’s personal assets are potentially at risk.
- Owner reports the profit and loss from the business on their personal tax return.
Learn more about sole proprietorships.
Partnerships
- Similar to the sole proprietorship, instead with multiple owners.
- Most states don’t require the partnership as an entity to file, making them easy and inexpensive to start. Most states do require partnerships to file a fictitious name/assumed name/doing business as or DBA with the county where the business is located.
- All partners are personally liable should the partnership be sued.
- Owners report their share of profit and loss on their personal tax returns.
Learn more about partnerships.
Corporations
- Formal filing with the Secretary of State (or similarly named state agency) that creates an entity that is legally separate from its owners.
- If the entity is sued, the owner’s personal assets are usually protected.
- Most complex of the four entities to administer as there must be an annual board of directors meeting, shareholder’s meeting, and minutes taken at the meeting to maintain liability protection. Can still be owned and operated by a single owner.
- 2 types of corporations are differentiated by a tax election with the IRS
C Corporation
- New corporations are classified as a C Corporation by default
- Typically best for businesses receiving significant investment
- Subject to double taxation as profits are taxed and then dividends to shareholders are also taxed.
- Can have unlimited shareholders
Learn more about C Corporations.
S Corporations
- Typically best for smaller businesses without a lot of investment.
- Considered a “pass-through entity” where the corporation isn’t taxed. Profits and losses are passed to the shareholders, who report them on their personal tax returns.
- Limited to only 75 shareholders, who must be U.S. citizens or residents.
Learn more about S Corporations.
Limited Liability Companies (LLCs)
- Provides the ease of operation like the sole proprietorship or partnership with the liability protection of the corporation.
- Formal filing with the Secretary of State (or similarly named state agency) that creates an entity that is legally separate from its owners.
- If the entity is sued, the owner’s personal assets are usually protected.
- Unlike the corporation, the LLC is not required to have an annual board of directors meeting, shareholder meeting, or take minutes at the meeting.
- Offers the greatest flexibility in how the entity is taxed. Can choose between electing to be taxed like a sole proprietorship, partnership, C Corporation, or S Corporation. This election can also be changed later as the business changes.
