Starting a business today is easier than ever. With the help of the internet, anyone can set up their business and start providing different services. As a business owner, one of the first decisions you make is determining which legal structure you want to base your company on.
It is an extremely important decision as it can determine the success of your business. So in this article, we will discuss the details of four common business legal structures to determine which one best suits your business.
Disclaimer: This article is not legal advice; you should consult professional legal guidance to make the right decision. This article aims to learn about different legal structures and, depending on your situation, the long-term impact they may have on your company.
4 Types of Legal Structures for Business:
There are several things to consider before choosing the right business legal structure. Each of the structures has its pros and cons. As a business owner, you should choose the one that best fits your needs.
1. Sole Proprietorship
First on our list is a Sole Proprietorship. A type of business entirely owned and operated by an individual. Sole proprietorships have no legal distinction between the owner and the business itself. Because there are no legal obligations, it is one of the most popular business structures and arguably the easiest to set up.
Taxation: For simplicity, sole proprietorship businesses do not have to file a tax return. Instead, the owner is liable for all taxes and will include the details under their own tax return through a Schedule C act (Form 1040).
Liability: The sole proprietorship’s owner is personally liable for all business debts. This is extremely risky as the sole proprietorship’s owner has to pay for all business expenses if the company fails to fund on its own.
2. General Partnership
The General Partnership business structure is worth checking out if you have multiple partners in a business. General partnerships are easy to create but may require a partnership agreement to be filled up and sent to the authority.
Taxes: A partnership is not required to pay federal income tax, but it must submit an annual information return (Form 1065) with the IRS to disclose earnings and losses from operations. Based on the owners’ profit-sharing quotas specified in the Partnership Agreement, profits and losses then distribute to them. Each partner pays taxes on their portion of the profit or loss they incur.
Liability: Like a sole proprietorship, the general partnership also requires owners to pay off full business expenses.
3. Limited Liability Company (LLC)
Limited Liability Company, LLC, is by far the most popular business structure in 2022. You can think of LLC as a hybrid between a general partnership and a sole proprietorship. So, it brings out the best of both worlds to you. LLCs include an easy setup. Anyone following along can quickly get started.
Taxation: Taxes are paid as “pass-through entities.” By doing so, business revenue is distributed to LLC members, who then declare their respective shares of profits or losses on their personal income tax returns. Similar to a general partnership, an LLC firm must submit an informative tax return to the Internal Revenue Service (IRS).
The tax rate also depends on which state you have set up your LLC. For example, setting up an LLC in Ohio will be more expensive (because of 15.3% tax) than in Delaware where you pay a flat $300/year.
Liability: LLC protects members from personal responsibility for the debts and claims of the company. Only the business’s own assets are in danger if a limited liability company is sued or has a debt. Therefore your personal assets are protected.
Note: In circumstances of fraud or unlawful activity, creditors are not permitted to access the personal assets of LLC members. LLC companies also have to follow certain state rules, which you can learn more about by clicking here.
The most complicated type of company structure is a corporation. A business owned or operated by shareholders. But it exists in law as a distinct, independent entity.
A company can enter into commitments that are independent of those of the owners, but all members still have obligations, such as paying taxes. In general, corporations are better suitable for larger, more established businesses with several workers.
Taxation: There are two types of corporations, C-Corp and S-Corp. Both have different tax policies, and while C-corp exists as a separate company and has to fill its own taxes, S-Corp is different and passes corporate income or loss through shareholders for federal tax purposes.
Liability: Corporation has a type of liability that is often called “immortal.” This is because the liability of a corporation will not go away even if you die. Although different laws protect owners, such individuals can not lose more money than they invested into a company.