Starting a business requires an appropriate structure to operate effectively and legally. Individuals or companies should adopt the business plan that makes the most sense for them, whether that is based on divergent tax policies or appropriate liability protection.
As a trusted Dallas law firm, Ritter Spencer PLLC can help determine the best structure for your business. The following categories break down the best business structures with four standard options that can help new owners decide which business formation option is right for them.
What is a Sole Proprietorship?
A sole proprietorship gives the owner complete control over their business. Starting a sole proprietorship does not require official regulation, and any entrepreneur who does not register for another type of business is considered a sole proprietor by default.
Who Should Start a Sole Proprietorship?
A sole proprietorship is a good starting point for low-risk businesses. It is ideal for contractors or those who do not have a clear direction yet. Often, a sole proprietorship will eventually become a limited liability company.
How to Start a Sole Proprietorship
The lack of formality means sole proprietorships are relatively easy to form. Depending on the nature of the business, a license may still be necessary, as are the proper 1040 and Schedule C tax forms. Other than those preliminary steps, the business owner can begin operating.
Pros and Cons of a Sole Proprietorship
Sole proprietorships are easy and inexpensive to create. They offer a simple tax process that does not require a business ID from the Internal Revenue Service (IRS). Everything is straightforward and tied directly to the owner.
The simplicity of a sole proprietorship, while convenient, leaves room for financial issues. It is challenging to raise money without selling stock, and banks are cautious about lending money to a sole proprietor. The business and its owner are tightly intertwined, leading to unlimited liability that can leave the owner in legal and financial trouble if the company fails.
What is a Partnership?
A partnership is the best way for two or more people to own a business together. There are two types of partnerships: limited partnerships and limited liability partnerships.
In a limited liability partnership, only one partner has unlimited liability, while the rest have limited liability. The partner with total liability tends to have the most control over the business and may pay self-employment taxes.
In a limited partnership, every partner has limited liability, which protects each partner from the actions of others.
Who Should Start a Partnership?
A partnership is a good structural choice for businesses with multiple owners or groups like attorneys.
How to Start a Partnership
Deciding on who the partners will be is the first step and next is determining the type of partnership. Then, the partners need to register with the state, get a tax ID number, obtain other registrations, licenses, or permits, and create a partnership agreement.
Pros and Cons of a Partnership
Nobody is alone in running a partnership, and teamwork fosters both growth and security. There is also less paperwork, fewer tax forms, and less financial burden when it is shared between partners.
A con with working on a team is that no owner has complete autonomy over their business. Partners will have to share ideas along with profits. Depending on the type of partnership, a partner may be tied strongly to it with unlimited liability, which inherently involves risks.
What is an LLC?
A limited liability company, or LLC, combines the advantages of a corporation and partnership with limited liability and a lower tax rate than corporations. Owners are considered self-employed and can pass through profits and losses to personal income, avoiding corporate taxes.
Who Should Start an LLC?
Any medium- or high-risk business, an owner with significant personal assets, and those who want to avoid high corporate taxes should consider an LLC. This structure helps protect the personal savings and belongings of entrepreneurs. It is also regarded as the best structure for most small businesses because it is inexpensive and easy to form.
How to Start an LLC
Choosing a name is the first step to starting an LLC. Next is selecting a registered agent who will be available if someone sues the business. The third and fourth steps are filing for the LLC’s certificate of formation and creating an LLC operating agreement. The final stage is obtaining a tax ID number for the LLC.
Pros and Cons of an LLC
An LLC provides limited liability to its members, and the pass-through taxation system means profits go directly to members. Another advantage is that the application and upkeep of an LLC are easy for small business owners.
The limited liability may not apply to all situations, and an owner may be personally liable in some cases. Another con to LLCs is that self-employment taxes can add up quickly, though the taxes are not as significant as those in a corporation.
A corporation is a legal entity separate from its owners. There are several tax classifications of corporations, with three common types detailed below.
What is a C-Corporation?
A C-corporation, unlike a sole proprietorship, exists as a legal entity separate from its owners. A C-corporation offers its owners the most robust protection of all the business types regarding personal liability. Regulation for a C-corporation is strict, with many requirements for record-keeping and reporting in place.
Who Should Start a C-Corporation?
Businesses with medium- or high-risk operations should consider C-corporations for the security they offer. A company that needs to raise money qualifies as another good candidate for C-corporation status.
How to Start a C-Corporation
The first step to starting a C-corporation is choosing a name and, more importantly, making sure it is available when registering for a tax ID number. From there, the directors appoint officers and file articles of incorporation with the state. Next, the owner issues stock to the shareholders. After the owner obtains any other licenses or permits, meetings can begin.
Pros and Cons of a C-Corporation
Limited liability for the directors, shareholders, employees, and officers is one of the essential advantages to a C-corporation. The legal operations are entirely separate from personal debt, meaning any unreliable members or business issues will not lead to personal detriment. The capacity to offer stock paves the way for large amounts of capital to be used in the future of the business.
Applying for and maintaining a C-corporation is time-consuming due to all of the regulations that must be followed. A C-corporation is also an expensive endeavor, not to mention that owners and operators may pay income tax on profits, meaning double taxation. Some owners register for an S-corporation to avoid C-corporation double taxation, despite the fact that there are critical differences between the two.
What is an S-Corporation?
S-corporations are designed to avoid the double taxation drawback of regular C-corporations. They allow some profits and losses to be passed through directly to an owner’s personal income without ever being subjected to corporate tax rates. Most states recognize S-corporations, but some do not and some tax above a certain limit.
Who Should Start an S-Corporation?
Businesses that would otherwise be a C-corporation but qualify for the S-corporation status may want to consider this structure. S-corporations are also ideal for businesses with 100 shareholders or less. Shareholders must be individuals, certain trusts and estates, or specific tax-exempt organizations.
How to Start an S-Corporation
Businesses must meet certain IRS requirements to be an S-corporation, such as domestic incorporation, only one class of stock, no more than 100 shareholders, and shareholders must meet the eligibility requirements listed above.
Pros and Cons of an S-Corporation
S-corporations get the tax benefits of partnerships with all other advantages of a corporation. They are protected with limited liability and transfer of interests but associated with prestige and credibility. The cons include the cost of incorporation with complex compliance rules and potentially growth-inhibiting qualifications to maintain status.
What is a B-Corporation?
B-corporations—or Benefit corporations—meet certain standards of social responsibility and environmental performance with a delicate balance of profit and purpose.
Who Should Start a B-Corporation?
A company that prioritizes social and environmental values over shareholder returns should look into becoming a B-corporation. A business should not bend to try and fit B-corporation standards but should only get assessed if their mission already aligns.
How to Start a B-Corporation
In order to start a B-corporation, a business owner must meet the assessment criteria, which includes the categories of governance, workers, community impact, environmental impact, and impact business models. The next steps are to amend legal documents, sign the term sheet, pay the related fee, then sign a declaration of interdependence.
Pros and Cons of a B-Corporation
A B-corporation is a great move to balance financial and non-financial interests. It gives companies an advantage when hiring candidates with similar interests, and it also helps with publicity. At the same time, acceptance is hard and there are no added tax benefits. Plus, B-corporations are not recognized in every state.
Aside from these four popular business structures, several other common ones include close corporations, non-profits, and cooperatives. No matter your business structure, Ritter Spencer can provide legal counsel that will help you better run your company. Make sure you apply for the proper business structure and understand the potential risks and rewards by working with the experts at Ritter Spencer today.