Choosing the right legal business structure is the first step towards incorporating your business. It is imperative to understand the pros and cons of different structures before finalizing the best one for your business.

Types of business structures

The common types of business structures include corporations, sole proprietorships, partnerships, cooperatives, and Limited Liability Companies. Let’s understand each of them through this article today.

Limited Liability Company

As per Brian Cairns, CEO of Pro Strategix Consulting, “Limited liability Companies were created to provide business owners with the liability protection that corporations enjoy while allowing earnings and losses to pass through to the owners as income on their tax returns”.

He further added that LLCs can have one or more members, and profits and losses do not have to be divided equally among the members”. In a Limited Liability Company (LLC), owners/partners/shareholders are entitled to limit their responsibilities while partners enjoy the tax and flexibility benefits of the partnership.

In this type of business structure, the partners are protected from the personal liability related to business debts if the illegal or unethical activities related to business activities cannot be proved. LLC can be the best choice for medium/high-risk businesses wherein the owners have strong personal background and assets to protect themselves and are interested in paying lower tax rates as compared to a corporation.

corporation is a legal entity

A corporation is a legal entity comprising an independent identity that is distinct from its founders. It holds the liability of the complete organization and its operations as well as liable to tax and legal actions for its activities. It can sell goods and services, make profits, and don’t hold any personal liability towards the corporation. However, one of the biggest disadvantages of forming a Corporation is the cost required to form a corporation and its extensive record-keeping.

The business is not affected by the owner’s death or transferring shares by its owners and continues to operate as preferred by the investors, creditors, and customers. It is easy to raise investment from various investment sources for a business that is incorporated. Also, a corporate structure is formed under various state laws with their legal obligations. An attorney is required to manage all the legal documents formally or it may lead to penalties.

Partnership is the simplest form of business structure

It is the simplest form of business structure for the combined ownership of business between two or more partners. There are two types of partnership business- Limited Partnerships (LP) and Limited Liability Partnerships (LLP).  In the Limited Partnership structure, there is only one general partner with unlimited liability while all the other partners are entitled to limited liability with limited control over the company as documented in the partnership agreement amongst all the partners. Profits are shared through the personal tax returns and the partner with limited liability should also pay self-employment taxes. 

In the Limited Liability partnerships, the owners have limited liabilities yet the bigger advantage is that it protects the owners from debts against the partnership. In an LLP, partners aren’t responsible for the actions of other partners. It is the best choice for businesses with multiple owners, professional groups such as attorneys, multispecialty clinics, and entrepreneurs who want to test their business ideas before investing in business formally.

Cooperative

A cooperative is a business or an organization that is operated for the benefit of those using its services, usually owners. The profits and earnings generated through business operations are distributed amongst the members known as user-owners. In a cooperative setup, the elected board of directors and officers manage the business activities and regular members have voting rights to control the cooperative. They can purchase shares to become a part of the cooperative however it doesn’t affect their power to vote.

Sole proprietorship

It provides complete control of the business to the owner. You are automatically considered the sole proprietor of your business if you haven’t registered it as any other kind of business. In the sole proprietorship, your business assets and liabilities aren’t separated from the personal assets and liabilities. You will have personal liability towards all the debts and obligations. In this type of business structure, you can manage to get a trade name however it is impossible to raise money as you cannot sell stock and banks too are hesitant to lend money. It is a perfect choice for low-risk businesses and people who just test their business ideas before forming a formal business venture.

Difference between C-Corp and S-Corp (Corporation)

The C-Corp and S-Corp is the default corporation formed under the IRS (Internal Revenue System) rules. Both are formed to offer financial protection. The S-Corp is a corporation with a special tax status under the IRS offering tax advantages. They derive their names from different parts of the Internal Revenue Code under which they are taxed. The C-Corps are taxed under Subchapter C wherein the S-Corps are taxed under Subchapter S. There are several differences between the C-Corp and S-Corp in many areas as mentioned below:

Taxation

• The C-Corps are taxed separately. They can file a corporate tax return and pay taxes at the corporate level through Form 1120. In this type of setup, the corporate income is distributed as dividends amongst the business owners and referred to as the personal taxable income which is liable for double taxation. First, the corporate income tax is paid at the corporate level and then as dividends at the individual level.
• The S-corps are known as pass-through taxation entities and file an informational federal return (Form 1120S). In doesn’t require to pay income tax at the corporate level an informational federal return is filed through Form 1120S. The profits & losses are passed through the business to the owner’s tax returns.
• For both the C-Corp and S-Corp the personal income tax is due on the salary drawn and dividends received from the corporation.

Corporate ownership

The IRS has placed several limitations on who can be shareholders for the corporation to become a qualified S Corp. However, state corporation laws don’t create any distinction between S Corps and C Corps.

• In C-Corps there is no restriction on ownership wherein S-Corps there is a restriction of maximum of 100 shareholders who should be US citizens/residents.
• C-Corps can own multiple classes compared to S-Corps which can have only oneclass of stock.
• C-Corps cannot own S-Corps. Neither can they be owned by any other S-Corps barring a few exceptions, LLCs, trust, or any partnership firms.