If you are starting a business or making changes to an existing business, you will need to determine what type of business you want it to be. This doesn't mean figuring out what you will do, what your mission statement will be or how you will compete in the marketplace. It means that you will have to establish your business structure.
As noted on the Internal Revenue Service website, there are five types of business structures: sole proprietorship, partnership, corporation, S corporation and limited liability company. In this post we will look at the very basic distinctions between these structures.
- Sole proprietorship: This structure ties you, the owner, directly to the business. You receive the profits and are responsible for covering expenses and debts. There are no separate taxes on the business.
- Partnership: At least two people must be involved in a partnership. As the name suggests, they are parties who work together in a business. As such, each partner receives a share of the income from the business and is responsible for debts and tax payment.
- Corporation: Larger organizations with multiple employees are often structured as corporations that have stockholders. Corporations are eligible for special tax deductions and are separate taxpaying entities, meaning the corporation takes on the financial liabilities.
- S corporation: Should the corporations choose to pass on this liability to shareholders, it would be considered an S corporation. Shareholders then report income gains and losses on personal tax returns.
- Limited liability company: An LLC has a combination of elements of different structures. How it is treated by the IRS will depend on elections made by members, who are the owners of an LLC.
The business structure you choose will have an impact on your its efficiency, taxes and legal requirements. This is why it will be important that you understand what these structures are, how they may apply to you and what potential benefits and drawbacks exist. Working with an attorney during this process can help you assess your options and avoid costly tax and legal issues.