Choosing the Right Business Structure is Critical

Choosing the right business format is a critical step in establishing your business venture. Each structure has unique features, from tax implications to liability protections, that can significantly impact your operations and goals.

A sole proprietorship is the simplest and least expensive business structure to create and operate. As the owner, you report profits or losses on your personal tax return and bear full personal liability for business debts. This format requires no formal corporate maintenance.

In a general partnership, all partners share personal liability for business debts and report profits or losses on their personal tax returns. Partnerships are simple and inexpensive to establish and operate. One key advantage is that general partners can use their personal resources or obtain financing based on their credit and assets without turning to external investors. This avoids diluting control or ownership, which would happen with external investors.

A limited partnership creates two kinds of business owners. Limited partners are those who do not participate in management. They have limited liability for business debt, but they receive returns, similar to dividends, on their investment. The second kind of owner, general partners, remain personally liable for business debts. While more expensive to set up than a general partnership, this structure is common among real estate companies.

A limited liability company provides owners the same protection from personal liability as a limited partnership. However, it also offers the option of partnership taxation. As a partnership, the LLC receives pass-through tax treatment, meaning that profits and losses are reported on the members' individual tax returns, thus avoiding the double taxation that corporations often face. (If the LLC instead chooses to operate as a corporation (either a C corporation or an S corporation), this benefit is lost. Although creating an LLC is more expensive than forming a sole proprietorship or partnership, an LLC is easier to maintain than a corporation.

A professional limited liability company offers the same advantages as an LLC, with additional benefits for state-licensed professionals. Members, who must belong to the same profession, are not personally liable for the malpractice of other members, though they remain liable for their own acts of malpractice. PLLCs receive pass-through tax treatment by default; however, single-member PLLCs are treated as sole proprietorships, while multi-member PLLCs are treated as partnerships unless they elect corporate status. This entity type is not available in all states.

A C corporation provides limited liability for its owners. Owners may take salaries or wages (which are deductible business expenses for the corporation) or dividends (which are not deductible business expenses). Owners may also balance how much income they take as salaries and instead leave profits in the corporation. This flexibility can help optimize individual taxation, particularly when individual income tax rates are higher than the corporate rate. C corporations can have an unlimited number of shareholders, and shares of stock can be sold to raise capital. However, they are more expensive to establish and require shareholder meetings to maintain corporate status.

Professional corporations are similar to C corporations but tailored for professionals in the same field. Owners are not liable for the malpractice of others but are liable for their own. Like a C corporation, this structure offers taxation benefits and requires meetings, minutes and reports to maintain corporate status.

S corporations combine limited liability for owners with pass-through taxation. Owners report their share of profits or losses on personal tax returns, and income is allocated according to ownership percentages. This structure allows shareholders to use corporate losses to offset income from other sources (e.g., wages or investments), reducing their overall tax liability. S corporations are more expensive to create and require greater formality than LLCs.

A nonprofit organization serves charitable, educational, religious or scientific purposes. Donors to NPOs enjoy tax-deductible giving. Formalities include annual meetings, reports and minutes. Property transferred to a nonprofit remains with the nonprofit and, if that nonprofit is dissolved, must be passed to another nonprofit.

This overview does not cover all the details and complexities of business structure, so consulting with business counselors, attorneys and accountants is highly recommended. While conversion to a different structure is possible at a later date, it may result in tax consequences or unintended dissolution.

Reach out to our team if you have questions about your existing business structure, and identify possible benefits of changing it.