The legal structure of a business will determine several factors relating to taxes, employees, shareholders, and liabilities. Each structure has its own rules, as well as different advantages/disadvantages to its operation and organization. We will review the differences below.
- Sole Proprietor-Often an individual entrepreneur will open as a self-employed business person. This is the easiest structure to understanding taxes. With this type of structure, there is no need to register the business because the entity will be the name of the owner. Filers can use a 1040 schedule C or schedule SE and avoid large amounts of paperwork. This type of business is often reserved for independent contractors, or consultants. A draw back to this type of business is that it is often hard to raise capital, as investors are looking for established organizations or corporations.
- LLC- A limited liability company is set up through state statutes. Here additional documentation is required, and often have registration fees for the start-up. The government does not recognize LLCs as a legal entity so taxes are passed through to the owner who files individually. The owner will file as as sole-proprietor, partnership, or corporation, but is obligated to pay employment tax on all net income. An LLC can have multiple owners that are called "members", it must have a registered agent and articles of incorporation. It is not necessary to have an operating agreement, but it may be encouraged when dealing with multiple owners discussing terms like profit or other business issues. The biggest incentive for having an LLC of course is the benefit of its liability protection. A member is not responsible for indebtedness or financial obligations with personal assets, and legal obligations are directed to the entity instead of the member personally.
- S-Corp- An S-Corp is set up through an IRS tax election and differs slightly from the traditional C-Corp, or corporation. In this situation, licenses and permits are required at registration and is more expensive than an LLC. This business is set up as a separate entity from the owner and taxes are directed to the shareholders and not passed through requiring an employment tax . Unlike a C-Corp, there is no double taxation in an S-Corp as only the shareholders are taxed on growth and not the business itself. Business expenses are deductible and shareholders have the right to sell stake in the business and walk away leaving the business still operational. More organization and paperwork is required as minutes must be recorded along with a record of the by-laws, adoptions, and stock transfers. The liability in a S-Corp is still limited; owners are not financially responsible but may not avoid employee tort action, or workplace injury.
- Partnership-This type of business is run by two or more people who share ownership. Each will contribute to starting capital, resource allocation, and have individual responsibility. Legal documentation is not required, but strongly encouraged if discussing important measures like profit sharing, business loss, taxes, and workload. There are three basic types of partnerships: general, lilited, and joint venture.
- Non-profit- The profits under a non-profit structure is used to improve the services rather than paying dividends to investors. This type of organization may be entitled to tax benefits or specific exemptions for various reason. things like federal grants, charities, and federal domestic assistance is available to these businesses.
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