Are you starting a new business and wondering what type of business structure to create? We’ve got the information you need to decide which business structure will work best for you.
When starting a business, there are so many business structure types to consider that it can be difficult to choose the one that works for you. There are at least 11 different business structures available today and we expect the possibilities will grow in the future.
We’ll help you understand what you should consider before you choose the legal structure of a business. Then we’ll discuss the different kinds of business entities and when each works best.
After we’ve given you all the information you need to choose your company structure, we’ll hook you up with one of our business partners to help you begin your business ownership.
Let’s look at how to choose which type of business structure will work for your business.
How to choose the right type of business structure
There are six questions to consider before you decide what type of business structure to choose:
- Do you want to keep your personal and business finances separate?
- What are your tax priorities?
- Will there be more than one business owner?
- Do you plan on hiring employees?
- Are you starting a business to make a profit or help people?
- Is your company meant to help the members achieve their goals by working together?
Let’s look at each of these questions to help you understand how each of these plays into choosing the right business structure.
Do you want to keep your personal and business finances separate?
There are business structures that help separate your business and personal finances and the liability that occurs if an employee gets hurt or a customer files a lawsuit.
If you can justify the additional costs, time spent submitting documents to government agencies, and processes to keep your business and personal finances separate, you should. But many of the business owners we interview on our YouTube channel tell people it’s better to get started than wait until you can do it perfectly.
In this interview, Notto Jensen tells us that his improvising became his greatest strength because he couldn’t afford overhead.
Every type of business entity, except for a sole proprietorship and a business partnership, can separate personal liability and assets from the business liability and assets as long as you use separate bank accounts for the business owned.
What are your tax priorities?
When considering what type of business entity to create, there are some questions you need to ask yourself about the tax treatment:
Is my business one that will qualify for tax-exempt status?
If so, you might want to consider a Non-Profit Organization (NPO) or Low-Profit Limited Liability Company (L3C).
Do I want to pay my business taxes on my personal tax return?
If yes, you should not consider a C-Corporation (C-Corp) or NPO. All others can be structured to allow pass-through income. All but general partnerships and sole proprietorships can be formed in ways that may allow separate business tax returns.
Are there any tax deductions or tax benefits that a business will qualify for that my personal income will not?
All but a sole proprietor or general partnership have some tax benefits that might outweigh the double taxation that can occur in other kinds of businesses.
What tax code do the different entities follow?
C-Corps follow subsection C, while S-Corporations (S-Corps) follow subsection S, and pass-through entities, like an LLC, will either be treated as a partnership or sole proprietorship, unless you file a Form 8832 to follow C-Corp laws. Co-ops are in Subsection T, which borrows from C, S, and K. Non-Profits are mostly in 501(c)(3).
I suggest you view the IRS Business Structures page for a more detailed understanding of the tax requirements for each type of business structure or talk to a tax consultant.
Will there be more than one business owner?
All types of businesses will allow for a single owner except for the different types of business partnerships, which have to be two or more people. An S-Corp has a limit of 100 owners, as do Benefit Corps (B Corps) and Co-Ops that are structured under S-Corp tax laws.
Sticking with a Limited Liability Company (LLC) is typically best unless:
- You have high enough profit margins that you can benefit from the corporate tax structure.
- Want to include your fringe benefits as tax-deductible. In that case, use a C-Corp.
- Qualify as a Non-Profit.
- Are trying to help benefit others without regard for getting most of the profit? In this scenario, Co-ops and B-Corps might make sense.
Do you plan on hiring employees?
If you plan on hiring employees, you’ll either want to do an LLC, LLP, corporation, NPO, or Co-Op. Do not hire people using a sole proprietorship or general partnerships as you have no legal protection if something goes wrong.
In Co-Ops, the employees may be the owners. Profit is divided by rules that require distribution based on how much each person uses the co-op as opposed to how much they invested. If you conduct business in this manner to make the investment returns fair, each employee’s investment needs to be equal to the work they put into the business.
Are you starting a business to make a profit or help people?
If you are trying to make a profit, you cannot be an NPO, but you can be an L3C that may qualify for tax exemption if you are investing in it through a foundation that is tax-exempt.
You also won’t want to be a Co-Op unless each member pays 1/X of the expenses, where X = the number of members. This is because of how a co-op divides profits compared to other types of businesses.
Is your company meant to help the members achieve their goals by working together?
If your company is meant to help people and make a profit, then your business operations may want to be formed under laws for Co-Ops or Benefit Corporations. These types of businesses are meant to be more profitable for the members or employees.
You’ll see this kind of business structure in credit unions and companies like Winco. Check out their video about their Employee Stock Ownership Plan below.
Now that you know about the types of business factors that determine what business structure types you can use, let’s look at the actual business types.
Types of business structures
There are 11 business types you may want to consider when starting a new business. We’ll look at the business legal structure for each of the following different business types:
- Sole Proprietorship
- Limited Liability Partnership (LLP)
- Limited Liability Company
- Series Limited Liability Company
- Non-Profit Organization
- Benefit Corporation
- Low-Profit Limited Liability Company
- Cooperative (Co-op)
Let’s start by looking at the easiest types of companies to create, sole proprietorships.
Creating sole proprietorships is the quickest, least expensive way of entering the world of business ownership, but they come with some risks that are only included when a business organization is not a separate legal entity, sometimes called a business entity.
For those of you wondering, “What is a business entity?” It is a company that is recognized as a separate legal entity from the person who owns it. This is beneficial because it separates:
- Business assets and personal assets
- Personal debt and business debt
- Business liability and personal liability
Unfortunately, sole proprietorships come with unlimited personal liability for business decisions. They are quick and easy to set up, but small business owners shouldn’t be putting their personal assets at risk if they default on business debts.
The Internal Revenue Code considers these small businesses under self-employment taxes which means you can:
- Claim expenses that employees cannot, but not as many as a corporation.
- Own assets for the business. For instance, if you own a building and don’t want to run the business anymore, you can close the business and rent the space to a new tenant.
- Have funds go directly into your personal bank accounts (this makes the next one much more difficult though).
- FIle the income with your personal tax returns. You will have to establish what is a business expense and personal expense. Check IRS Publication 334 for guidance on what you can claim and what you can’t.
- Self-employment tax means that small business owners have to pay 15.3% of the first $137,700 in 2020, $142,800 in 2021, and $147,000 of income for 2022. This cap is adjusted every year based on inflation. The IRS is the definitive source for self-employment taxes. Make sure to read about them.
Keep reading for information on Partnerships.
Partnerships can be one of two types, General Partnerships or Limited Partnerships. A General Partnership is when at least two people are participating in the business, while a Limited Partnership has at least one silent partner.
Both General Partnerships and Limited Partnerships have the same benefits:
- Easy to create
- Pass-through taxation, meaning they have the same benefits as a sole proprietorship regarding taxes
- Partners fully control the business
- You can get investors
Both Limited Partnerships and General Partnerships share the problems of:
- Unlimited liability for the business’s debts
- Personally liable for the other peoples’ actions
Like Sole Proprietors, these types of businesses are not recommended because of the lack of liability protection against a business’s debts.
The next type of partnership is far better when considering different types of businesses.
Limited Liability Partnership
Limited Liability Partnerships are similar to other Partnerships but come with protection against liability for others’ actions.
The benefits include:
- Only liable for others’ actions to the amount that you invested in the company (but still personally liable for your own actions)
- Independent legal entity
- Pass-through income
- 20% qualified basic income deduction. See IRS QBI page for more details.
- Easy to add partners
The issues with these business entities are:
- They are not offered for all industries in all states.
- Some states may require a franchise fee on top of the standard limited partnership and limited liability formation fees.
In most states, you will need a formal operating agreement and to register with the Secretary of State to create an LLP. You can find information for starting a business in your state at USA.gov.
Keep reading for information on Limited Liability Companies.
Limited Liability Company
When wondering, “What type of business should I register as?” you are going to inevitably be told to start an LLC. Most of the time they are right. The reasons everyone loves LLCs are:
- They separate personal and business liability.
- They can have as many members as you want.
- Anyone or any business entity can own an LLC.
- The business determines whether to file taxes as either a pass-through entity or a corporation.
The main drawbacks are:
- Raising capital can’t be done through selling shares.
- You can’t jump back and forth between corporate taxes and pass-through taxes.
- LLCs are more complex to start than a sole proprietorship.
- You’ll have more costs associated with setting up and maintaining an LLC.
You’ll need an operating agreement and articles of organization, which are fairly easy. You can create a separate business entity through our partner BetterLegal and save $30 when you create an LLC.
Keep reading for more ways of avoiding unlimited liability.
Series Limited Liability Company
A Series LLC is nearly identical to a normal LLC but with one distinguishing difference: You can have a parent LLC with multiple distinct LLCs underneath it. This is basically the same concept a conglomerate (Berkshire-Hathaway, for those unfamiliar) uses, but much less costly, making it perfect for:
- Serial entrepreneurs
- People who own multiple franchises
The benefits of a Series LLC over a normal LLC include:
- Lower cost than starting multiple LLCs
- Has the same benefits as an LLC, but can share costs
- Less complexity than conglomerates or thousands of non-series LLCs
The drawbacks are:
- More costly originally, but saves money the larger the series
- A larger series means more complexity. Only offered in the following locations: Alabama, Arkansas, Delaware, District of Columbia, Illinois, Indiana, Iowa, Kansas, Missouri, Montana, Nevada, North Dakota, Oklahoma, Puerto Rico, Tennessee, Texas, Utah, Virginia, Wyoming.
- Tax clarity due to series LLC being based on local laws
I’ve provided the links for some of the states. You can find your state by searching “register a Series LLC in (insert state).”
Before the 1990s, C-Corporations, those started under Subsection C of the U.S. tax code, accounted for the vast majority of the revenue in the U.S. Now they make up less than 50%. A C-Corporation has the following benefits:
- Able to sell stock
- Able to pay dividends to the owner reducing the taxable consequences
- Limited liability
- Easier to get investors
- Can offer yourself better benefits fully tax-deductible.
- Unlimited owners
Meanwhile, running a C-Corp includes many business challenges that are not included in other types of business organizations including:
- The corporate tax, which can be avoided through good estimating if you pay yourself enough
- Complexity due to filing and reporting requirements. Requirements can be found on the IRS website.
- Double taxation, need to pay taxes on corporate earnings and personal income
C-Corps are the most common type of corporation, but let’s look at the S-Corp next.
An S-Corporation is basically a baby corporation that has the following differences from a C-Corp:
- No more than 100 stockholders
- Only U.S. Citizens, resident aliens, some NPOs, and some trusts or estates can be owners. Check with a lawyer if you are thinking about starting an S-Corp and investing in it with an NPO, trust, or estate.
- Earnings are pass-through income
- Only one class of stock
- File under subsection S of U.S. tax code
To learn more about forming an S-Corporation, check out the IRS S-Corporations page.
Keep reading to learn about Non-Profit Corporations.
These types of businesses are specifically for companies that work for the better good of the community. They are typically in the medical field, free or low-cost legal services, churches, or other social services. The benefits of these types of corporations are:
- No corporate tax
- Legally allowed to receive donations to raise money
- Profits on the sale of a property can go to help people
NPOs are more complicated because:
- Approvals to raise money and provide the services are through the states, but the federal government has to approve an NPO to receive tax-exempt status.
- There are lots of legal documents required to keep your tax exemption.
- If the business closes, you have to donate the assets.
Unless you are specifically looking at types of business ownership that are serving the greater good and don’t want to make a profit, an NPO probably isn’t the best option for a small business.
When wondering, “What type of business should I start,” consider a benefit corporation if how you impact your community is important to you. This type of corporation is an addendum to an S-Corp or C-Corp. Follow the four steps below:
- Apply for an S-Corp or C-Corp.
- Mark the box that says, “I want to be a Benefit Corp.”
- Specify how the corporation intends to benefit the community.
- Create and publish a report of how you improved the community every year.
Remember to follow your state’s requirements to create a B-Corporation, and to learn more go to BenefitCorp.net.
Low-Profit Limited Liability Company (L3C)
L3Cs are used in nine states when an organization is focused on the greater good, but they may also earn a profit. These companies normally do not qualify for Non-Profit status, but they might be able to if all owners are Non-Profits and the business is within their core functions. If it doesn’t, then it will have taxable earnings.
These are primarily used by the Bill Gates Foundation and newspapers for projects that could turn a profit but don’t and rely on contributions to keep them going.
Use this option with caution because of the uncertainty in the tax treatment. I’d suggest going with a more established form of business, but you can learn more about L3C usage on UpCounsel.
A Co-Op is a group of people or businesses working together to achieve a goal. Co-Ops fall under Subchapters C, K, S, and/or T of the tax code depending on what legal structures they follow. The key difference between Co-Ops and other businesses is distributions are by usage, not investment.
The primary industries that use Co-Ops are agricultural, healthcare-related, community-funded energy projects, and employee-owned companies. You’ll definitely need a lawyer to establish the best strategy for Co-Ops, but check out Co-opLaw.org to learn more about how co-ops work.
I’d personally love to see more Co-Ops, but there needs to be a balance where employees get 33% of the profits, investors get 33% of the profits, and founders get 34% of the profits. I think this would truly be a great way of running a company for everyone involved.
Create a Business Structure Today
If you are ready to set up your business, go to your Secretary of State (SOS) website. Look for your SOS at search.usa.gov, or reach out to our partner BetterLegal to help you with all your business filing needs. BetterLegal handles everything from business formation to state and federal reporting within one to three weeks.
Regardless of whether you start a sole proprietorship, LLC, corporation, or another type of company, UpFlip has you covered. If you’re ready for the next step in the process, read our article on how to register a business.
What business structure are you leaning toward?