Determining the Best Legal Structure for Your Business

Business owners can choose from several standard business structures.

A sole proprietorship is a one-person business that typically doesn’t require registration with the state in which you operate your business, with the exception of fictitious name or doing-business-as (DBA) paperwork.

Here, the owner is the business and the business is the owner. There is no legal separation. The owner is personally responsible for all aspects of this business — from income tax (profits and losses) to liability (debts and judgments).

Typically, a sole proprietorship can be dissolved at any time by the owner and automatically terminates with the death of the owner.

A partnership is simply a business owned by two or more people. No special paperwork is required. The same responsibilities — tax and liabilities — that are associated with a sole proprietorship apply; however, in a partnership, they’re shared. How the responsibilities are distributed among the partners is determined by the partnership agreement.

An equal division of partnership may not be best. A company with 51% women ownership may qualify as a woman-owned business enterprise.

The partnership may function best with a legal agreement in place.

Another type of partnership is the limited partnership. This kind of partnership is not usually recommended for the average small-business owner. As a general rule, limited partnerships are created by one individual (or company), known as the general partner. The general partner solicits investments from others, who, in turn, are limited partners.

The general partner is liable for business debts.

This isn’t a business structure that should be created without the input of legal guidance. There are attorneys who specialize in this area.

The main benefit of a corporation or an LLC is that the owners’ personal liability for business debts and court judgments leveraged against the business is limited with these business structures.

A corporation is an independent entity, for legal and tax purposes; it’s separate from the people who own, control, or manage the business. The business isn’t synonymous with the owner, and the owner isn’t synonymous with the business — in structure.

In most cases, owners of a corporation don’t use personal tax returns to pay tax on corporate profits. As a separate entity, the corporation itself pays these taxes. Owners, however, pay personal income tax on money received from the corporation — as salaries, bonuses, and other forms of compensation.

An S Corporation is a form of corporation, allowed by the IRS for most companies with 75 or fewer shareholders, that allows the company to enjoy the benefits of incorporation while being taxed like a partnership or sole proprietorship.

A C Corporation, however, is completely separate from the owners and is taxed accordingly. The primary advantage of a C Corporation is its potential for a greater number of shareholders. For large firms that require outside investments, the S-Corporation limitation of 75 shareholders is too restrictive.

Alimited liability corporation (LLC) can potentially provide limited personal liability for business debts, claims, and judgments. However, LLCs are similar to partnerships in this regard to tax structure. The owners of an LLC report income or loss and pay taxes on their portion of the business income using personal tax returns.

Potential business owners who may be sued by another party, those who run the risk of substantial business debts, and individuals who wish to protect individual assets are all among those who should consider a corporate structure.

A non-profit corporation is formed to carry out a charitable, educational, religious, literary, or scientific purpose. Usually, non-profits raise their funds through public and private grant money. They can also solicit donations from individuals and companies.

While there are exceptions to this, federal and state governments generally don’t tax non-profit corporations on this money, as long as it’s related to the intended non-profit purpose.

In most cases, you can switch from one form of business to another without major consequences. Not all legal forms are transferable, however.

Regardless of the type of business you wish to form, one of your first steps should be a visit with a business attorney that can best guide you in this area.

Carol Parenzan Smalley is an educator, innovator, and entrepreneur. She is the creator of and instructor for Creating a Successful Business Plan, an online course offered by colleges and universities around the world.