Posted on May 6, 2016

Small Business Legal Structure

One important consideration when starting your business is determining the best legal organizational structure. Why? Because it will affect operating efficiency, transferability, control, the way you report income, the taxes you pay and your personal liability.

Four basic structure types are available:

  • Sole proprietorship
  • Partnership — general and limited
  • Corporation — S corporation, C corporation
  • Limited liability company (LLC)

The choices can be complicated — and errors can be costly. Business legal structures are regulated by state governments, but your county or municipality also may have license requirements. What’s more, current tax laws make it difficult to change your legal structure after you begin operating. Making the right decision before you open for business is very important. How do you decide which legal structure is best for you and avoid potential problems? Consult with a certified public accountant (CPA). A CPA can help you make well-informed choices, explain how business structure affects your organization’s bottom line and file the necessary paperwork to start your business, if you’d like.

Below we have listed the pros and cons to each structure type in an overview and comparison grid that will help you consider the right structure for your new business.

Business Structure Pros and Cons

Structure Type

Pros

Cons

Sole Proprietorship

  • Inexpensive to start and simple to run
  • One level of tax on net income
  • No separate tax return
  • Unlimited personal liability
  • Ownership limited to one person

Partnership

  • Ownership not limited to one person
  • One level of tax on net income
  • Income and expenses allocation can be unrelated to percentage of ownership
  • Unlimited personal liability
  • Each partner legally responsible for the business acts of other partners
  • Requires separate tax returns

S Corporation

  • Limited personal liability for shareholders
  • Business net income taxed as personal income of shareholders
  • Requires separate tax returns
  • Restrictions on adding investors
  • Net income must be allocated according to percentage of ownership

C Corporation

  • Limited personal liability for shareholders
  • Easy to transfer ownership and add investors
  • Perpetual continuity presumed
  • Requires separate tax returns
  • Net income may be double taxed
  • More costly to set up and maintain

Limited Liability Company (LLC)

  • Limited personal liability for members
  • Income and expenses can be allocated in a manner unrelated to percentage of ownership
  • Not automatically perpetual like S or C corps
  • More costly than a sole proprietorship to set up and maintain

 

Your CPA can help you decide what type of entity and structure is best for your particular situation and type of business. There are situations where forming multiple entities may better accomplish your objectives. For example, a family
business may want to separate its land, buildings or other fixed assets from the operating business and lease them back to the operating business to have a different equity ownership by family members who may not be active in the
business’s day-to-day operations. You should evaluate the decision to choose an entity in which the tax attributes pass through to the owners in light of the
other income or losses that you and other owners have and the extent to which you will have a tax basis in the entity. Other considerations include your objectives for an exit strategy or transitioning the business ownership on to the next generation.

Pages from SB Legal Structure Selection Guide - Publish

For more information on which legal structure is right for your business, download our Whitepaper – Guide to Selecting Your Small Business Legal Structure, which includes entity type comparisons of the following topics:

  • Operational and Control
  • Investment
  • Continuity and Transferability
  • Legal Liability
  • Compensation and Payroll Taxes
  • Tax Years

Contact the Cornwell Jackson Business Services team for more information. We’re small business experts.