A business legal structure is the foundation of a company. Essentially, it determines how the business is taxed, how it’s treated in bankruptcy proceedings, and how it’s formed.
To start, there are four main types of business structures in the United States: sole proprietorships, partnerships, limited liability companies (LLCs), and corporations (Inc.). If you want to know whats the difference between LLC and INC and the others, here’s an overview of their key structures, so you can choose the right one for your business’s needs.
Table of Contents
1. Sole Proprietorship
Based on its name, a sole proprietorship type of business is owned by one person — you. So, whether you’re selling your crafts in an online store or you own a small tutorial center, your structure is under sole proprietorship.
Since they’re typically simpler than other types of entities, they may be a good choice if you’re just starting and don’t have much in the way of resources or money. However, with this structure, getting a loan from a bank or raising money may be a challenge for you.
- How it’s formed
A sole proprietorship is the most straightforward business legal structure to set up. Depending on your state laws, you may not need any formal paperwork when registering your business. Instead, you may register your business with your local or state government and get the necessary licenses and permits, which generally require minimal costs.
And in some cases, some states may not require you to register your business if your business plan is only working as an independent contractor or running a very small, low-risk operation.
- How business is taxed
Since you and your business are not separate entities, taxes are deducted from your income made as the individual owner. Sole proprietors report their business income and expenses on Schedule C of their personal tax return and may also need to file Schedule SE (self-employment).
- How the business is treated in bankruptcy proceedings
During bankruptcy, the court will run after your assets to pay off creditors since, under sole proprietorships, your business has no separate entity from you.
2. Partnership
In a partnership, two or more people share ownership of a business. It can be general partnerships or limited partnerships. Each type of partnership has its set of advantages and disadvantages. And so, it’s essential to weigh them carefully to choose the right one for your business.
Essentially, general partnerships are considered the simplest and most common type of partnership. In a general partnership, each partner has a hand in managing the business. Limited partnerships have one or more general partners and another whose role is an investor only.
- How it’s formed
Similar to sole proprietorships, entities entering a partnership are generally not required to have a formal agreement. Thus, it’s extremely essential to have a partner you can trust, especially since you’ll be entrusting them with your reputation and credit score.
For some, creating a written partnership agreement to determine one’s responsibilities and profit shares can provide a somewhat safety net in case a problem surfaces. Furthermore, applying for a business license and registering an assumed business name can also help minimize the risks of getting into business with another person.
- How business is taxed
Like sole proprietorships, profits and losses are taxed from the partners. They may need to file forms, such as Annual Return of Income, Employment Taxes, and Excise Taxes.
- How it’s treated in bankruptcy proceedings
Depending on the kind of partnership you have, you may be treated differently during bankruptcy proceedings.
In a general partnership, your personal liability to the company may be unlimited. As a partner, you’re equally liable for the obligations and debts of the company. This means that in the failure of the business to pay off its creditors, the court may run after a partner’s assets.
On the other hand, in a limited partnership, your liability will rely on the amount of investment you’ve had in the business.
3. Limited Liability Company (LLC)
Another option for a business legal structure is an LLC, or limited liability company. This type still has features of sole proprietorship and partnership but can offer you protection from personal liability in the event your business is sued. This means that your personal assets, such as your home or savings, cannot be used to pay off business debts.
- How it’s formed
In comparison to sole proprietorship and partnership, forming an LLC is more complex. In this structure, you’ll need to name your business, choose a registered agent, file your articles of organization, and write an operating agreement. You also need to comply with industry-specific permits or licenses. Furthermore, you may also be required to file a “doing business as” (DBA) document in some states.
- How business is taxed
Like sole proprietorship and partnership, an LLC also allows losses and earnings to pass through its owners. However, it only allows you to get taxed on your profit shares.
- How it’s treated in bankruptcy proceedings
This type of structure shields you from personal liability in most circumstances, ensuring that your business and your personal assets remain separate. One thing to note, however, is that an LLC does not protect you from personal liability in all circumstances.
If you have personally guaranteed any debts for your business or took out a loan using your home as collateral, you may be held liable for those debts if your business ends up going bankrupt. Additionally, if it has been proven that you’ve acted negligently while carrying out your business activities, then you may also be held liable. If you’d like to find out more about business structures, check out this article on LLC’s by LegalVision.
4. Corporations
A corporation is generally an entity that is separate and distinct from its owners. They enjoy many of the same rights and responsibilities as individuals, including the right to enter into contracts, to sue and be sued, and to own property. One of the primary advantages of incorporating is that it limits the liability of the owners. This means that if something goes wrong with the business, the owners’ personal assets are protected. Another advantage is that corporations can raise capital by selling shares of stock.
- How it’s formed
A corporation can be formed as either a C-corporation, S-corporation, or B-Corporation. Generally speaking, the steps in forming a corporation include the following:
- Pick a business location
- Give your business a name
- Assign your board of directors
- Choose your registered agent
- Complete and file your articles of incorporation
- Write your bylaws
- Have a corporate record book
- Conduct your first board meeting
- Start issuing stocks
- How business is taxed
Corporations are taxed differently than other entities. They are filed separately from the personal taxes of owners. Double taxation may also be an issue depending on the type of corporation.
- How it’s treated in bankruptcy proceedings
Corporations offer the most protection against personal liability among the four structures. In general, it’s the corporation that gets sued, and never its officers or owners.
Conclusion
Knowing which legal structure you should choose for your business is an essential part of getting started in any new endeavor. And hopefully, with the insights above, you can be guided in assessing each type and figuring out which structure suits your business best.
