A Quick Guide to Selecting a Corporate Structure for Your Business
Today’s business world is full of more entrepreneurs than ever before. And if you’re looking to start your own business, it can be easy to let your excitement run away with you, and dive straight in without considering all of the little details that come with setting up your own company. One of the details that many new business owners overlook is selecting the right business structure. Here’s what you need to know about selecting the corporate structure for your company.
Why Does It Matter?
First, let’s talk about why this matters. If you’re new to the business world, you might think that a business is a business. However, there are actually 9 different business designations out there, and they all mean something slightly different for your business. Your corporate structure impacts your taxes, your ability to earn money, what paperwork you have to file, as well as your personal liability should anything go wrong.
You’ll need to select the right business structure before you register your business, and will need to get a tax ID number and file for any necessary licenses and permits. If you’ve already registered your business with the state, and you’re just reading this, you may be able to convert to a different business structure; however, this can have unexpected consequences in some states, so be sure to consult with our business accountants.
Now, let’s get into the different types of business structures, so you can ensure you select the right one for your company.
There are actually 5 different types of business structures that fall under corporations. We’ll talk a little bit about each of them.
A C corp, sometimes simply referred to as a corporation, is considered a legal entity that is separate from its owners. This provides the owners with a lot of protection from personal liability, and allows the company to continue on with very little disturbance should a shareholder decide to leave the company. They can also raise money through the sale of stocks.
However, income on corporations may be taxed twice—when the company makes a profit, and when the dividends are paid out to the shareholders. Corporations are also more costly to form than other business structures, and require more detailed record-keeping, operational processes, and reports.
While similar to C corps in many ways—it’s an independent entity that offers liability protection and allows the business to continue with little disturbance should a shareholder leave—there are still a few differences. First, it’s important to know that some states don’t recognize S corps at all, and simply treat them as C corps. Additionally, you should be aware that you need to file with the IRS to get an S corp designation for your business, in addition to registering with your state.
However, S corps have some limitations that C corps don’t—most notably in relation to its shareholders. S corps cannot have more than 100 shareholders, and all of them must be US citizens. Profits and, in some cases, losses can be passed on to the owners to avoid corporate tax rates as well.
B corps, or benefit corporations, are taxed in the same way as C corps. However, they differ from C corps in their purpose, accountability, and transparency. B corps are expect to provide a public benefit in addition to earning a financial profit for its shareholders. Some states even require B corps to submit an annual benefits report to show how they’ve contribute to the public good.
These corporations resemble B corps, but with a less strict corporate structure. Shares in close corporations may be barred from public trading depending on the state you’re in.
As the name implies, nonprofit corporations are operated for charity work, or some other type of work for the public good, and not to turn a profit for shareholders. This can give your company tax-exempt status, but you must register with the IRS and follow very strict rules regarding what you do with any profits you earn.
A sole proprietorship is a fairly common business designation, as it’s easy to form and gives you total control of your business. It’s a great option for first-time business owners who want to test their business idea before creating a more formal business structure.
However, a sole proprietorship doesn’t create a separate entity, so your business assets and liabilities are not separated from your personal ones. This means you can be held personally liable for any debts, obligations, and even lawsuits connected to your business.
If you are going into business with one or more other people, a partnership is the simplest business structure to use. There are actually 2 common types of partnerships—limited partnerships (LP) and limited liability partnerships (LLP). In both types, profits are passed onto the partners’ individual income tax returns.
In an LP, there is typically one partner with unlimited liability, while all others have limited liability. The partner with unlimited liability typically has more control over the company, and must pay self-employment taxes.
LLPs offer limited liability to all owners. This protects each partner from debts against the partnership, and ensures they are not responsible for the actions of other partners
Limited Liability Companies
A limited liability company, or LLC, allows you to reap the benefits offered by both corporation and partnership structures. LLC designation protects your personal assets from any business-related liabilities or lawsuits. Profits and losses can be passed to your personal income so you don’t face corporate taxes, but you will need to pay self-employment taxes on it.
One drawback is that, in some states, you may have to dissolve and re-form your company if a member joins or leaves your LLC. However, this can be avoided if you set up an agreement for buying, selling, and transferring ownership in advance.
If you’re setting up your own company, be sure to speak to an accountant to get a better understanding of the financial implications of each business designation. Selecting the right corporate structure can make a huge difference in how your business operates, as well as how much you pay in taxes. Contact our business accounting experts now to learn more.