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Comparing Business Legal Structures

Dustin RayVP Business Development, IncFile.com

For the first-time business owner, choosing the best organizational structure for your company can seem like a daunting task. What exactly is an LLC? What are the differences between C-corporations and S-corporations? Is a sole proprietorship a good idea?

Confusion is common, and the devils are in the details, so make sure you know the advantages and drawbacks of each business formation so you can make the best choice for your company. Below, we’ll compare the pros and cons of each business legal structure.

Sole Proprietorships & Partnerships

A sole proprietorship is an ideal structure for a person who wants to own a business on his or her own. It’s as easy as starting a business, requiring no paperwork whatsoever.

A partnership is effectively like a sole proprietorship, except that it’s owned by two or more people, and typically is governed by a partnership agreement.

Pros

Cons

A partnership or sole proprietorship is most beneficial for a single owner or close set of business partners who want to set up shop quickly and easily, and have the personal assets to protect their business.

Limited Liability Company (LLC)

For a small-business owner, an LLC—or limited liability company—is the most popular choice. In fact, 80% of small businesses choose this organizational structure, citing its flexibility and the protections it offers by and limiting the legal liabilities of its members.

An LLC is a private limited company and, unlike a corporation, has a much more freedom in two important areas: organizational structure and taxation.

The organizational structure of an LLC is notable for its flexibility. There are no formal restrictions on LLC structure, which is frequently beneficial for new companies, particularly as they expand in size and profitability. Conversely, corporations have quite rigid organizational restrictions, such requiring of a Board of Directors, and so are not conducive to the mercurial nature of startups and many new businesses.

For taxation purposes, the IRS classifies an LLC as pass-through entities, which means they are only taxed once, at the individual level. The LLC itself pays no taxes. Corporations, on the other hand, are taxed at both the company level and the individual level, which is often a strong disincentive for new businesses to form with that structure.

Pros of LLCs

There are a number of advantages to forming your company as an LLC.

Cons of LLCs

Do note that you may have to file a business tax return, even if no taxes are paid at the business level, if the LLC is owned by two or more people.

The LLC organizational style is best suited to high-risk small businesses, as the structure limits personal liability. It may also be beneficial for businesses seeking flexibility.

Comparing Business Legal Structures

S-Corporation

The S-corp entity type has a lot in common with an LLC. Both are considered limited-liability, protecting your personal assets from being seized for business debt. Both offer pass-through taxation, effectively sheltering owners from higher business tax rates.

There are some differences, however. Namely, an S-corp is bound by more rules and requirements than an LLC.

Pros of S-Corp

An S-Corp is preferable to an LLC in specific situations, particularly when it comes to taxation. S-corp owners’ salaries are often self-determined and taxed as income, however dividends are paid—and thus taxed—separately. This can save 10% to 15% in taxes over the course of the year, though bookkeeping and related costs will be higher than they are for an LLC.

Cons of S-Corps

S-corporations are useful for business owners who wish to pay themselves salaries, take advantage of the tax savings that come with a dividend structure, and/or want to make their companies permanent entities. The S-corp structure also simplifies the steps required to transfer ownership or shut down the business.

C-Corporations

The C-corp stands out among other business structures because they are taxable entities. This allows the tax burden to be split between the corporation itself and the owners, with the benefit that each is placed in a lower tax bracket than under other business structures. C-corps tend to be more complex than LLCs and S-corps and so incur higher costs for accounting and legal matters as well.

Outside of taxes, in other structural particulars C-corps are generally similar to S-corps, but they do have a some key differences:

C-Corp Pros

C-Corp Cons

C-corps are an ideal structure for larger, well-established companies that have little risk of failure, and companies that want to raise capital by utilizing multiple stock class options.

Nonprofits

The nonprofit structure is specifically for organizations that aim to contribute to the greater good, and are conferred special status in various ways. However, there are numerous regulations for this entity type and it should only be chosen in very specific and well-thought-out circumstances.

Pros of Nonprofits

Cons of Nonprofits

If your business’ main priority is to benefit the public, a nonprofit is the logical choice, as the business will be exempt from all taxation.

Which Structure Works for You?

The overwhelming majority of new businesses, and almost all startups, take the form of either an LLC or an S-Corp, but the choice may still not be clear. So how do you choose between an S-corp and an LLC?

Ask yourself if you are:

(A) Comfortable with a capped amount of shareholders, confident in your ability to make quarterly IRS payments, and able to keep up with the stringent rules and regulations that go hand in hand with significant tax advantages?

(B) Willing to take on the additional risk that comes with having your personal assets tied to your business? Do you enjoy the control that comes with making your own decisions and not being held accountable to a large number of other owners?

(C) Able to pay the high set up fees that are required to file your Articles of Incorporation? Are you comfortable with a significant amount of government oversight in exchange for benefits such as perpetual existence and no shareholder cap?

(D) Looking for more flexibility regarding your company’s owners? Do you prefer to make your own decisions about how your profits should be distributed? Would you rather focus on your business instead of record-keeping?

If you said A, an S-corp is probably right for your company.

If you said B, a sole proprietorship or partnership may be in your best interests.

If you chose C, a C-corp will best align with your preferences.

If you chose D, then an LLC is the best option

Choosing which business structure to use is one of the most important decisions you’ll make when it comes to your new company. When you’re armed with all the necessary information, the solution becomes much clearer.

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