When launching a business, one of the most important decisions is choosing the type of legal structure for your future company. This choice impacts the amount of money you should pay in taxes as well as the personal liability, funding, and a number of paperwork you need to do. There are several different types of business structure and each has its own funding and tax consequences. Here’s your guide to the most popular types of business structure to help you make your final choice:
Also called, sole proprietorship and solopreneurship, a sole trader is a business run by one person. Apart from being the simplest business structure, a sole proprietorship allows you to own and operate the entire enterprise alone and thus earn money for yourself. The most appealing part of this structure is definitely taxes. The income from the business and all the expenses related to it are included in the Form 1040, which is your personal income tax return.
Sole trader has fewer legal controls and a huge flexibility of management. However, as a solopreneur, you’ll be responsible for the company’s liabilities. Plus, you’ll need to tackle some startup tasks alone. You’ll need to register a company name via a company formation such as 1st formations, find the funding sources, and manage other documents.
When a company is owned by two or more people, this business structure is called a general partnership. Unless otherwise mentioned in a partnership agreement, each partner shares the management, losses, and profits of the business, and is equally and personally liable for the possible debts of the partnership. General partnership doesn’t have a company-level taxation and all the profits are taxed at the personal income level. The downside of this partnership is rivalry. Not to mention that partners often have issues with a mutual management.
Also known as a limited company, this business structure involves one or more general partners and one or a few limited partners. Limited partners don’t take part in the daily operations of the company and their losses in the business are limited to the extent of the amount of cash they invested in it. In other words, limited partners are just passive investors who don’t have any personal liability.
Unlike sole proprietorships, general and limited partnerships are much more expensive to start. Additionally, you’ll need to post annual financial reports and accounts on a public domain. Limited partners pay a corporation tax on their profits while the CEOs of the company are taxed in the same way as employees.
Limited Liability Partnership (LLP)
Similar to general and limited partnerships, LLP means that two or more partners have limited liabilities, but have no responsibility for the negligence of another partner. LLP is usually created by professionals, such as an entrepreneur with a huge business experience, lawyers, and accountants.
Corporation (C Corp)
The law treats a corporation, which exists separately from the owners, as an independent legal entity. It’s one of the most complex business structures that allows removing or adding shareholders, expanding businesses. A corporation is generally double-taxed. This means that the personal income of each shareholder is taxed and the company itself is also taxed but as a business entity. Corporations tend to pay the licensing fees and require a constant flow of investments.
Limited Liability Company (LLC)
Formed by one or more people or entities, LLC is another popular and effective way to structure your business. LLC is similar to partnerships and corporations and is allowed to try any lawful, for-profit activity or business other than insurance or banking. This means, the tax responsibilities are reserved for partnerships and the protections for corporations (personal and business liabilities are separate). The perk of LLC is that it’s highly flexible and there’s no double corporate taxation.
When choosing your business structure, focus on the one that will bring more joy, profits, and freedom into your entrepreneur life. It’s best to find a qualified business law attorney to help you handle the tax issues and register your startup.