What To Ask Yourself Before Selecting a Business Type

One of the first steps you’ll take when you form a business is to choose a structure for your company. The type you choose will determine how profits are taxed, who’s liable for business debts, and how ownership in the company is held.

Here are some questions to consider that may help you decide which business type to use.

Key Takeaways

• The common types of business structures include sole proprietorships, partnerships, LLCs, and corporations.
• Sole proprietorships, partnerships, and LLCs will pass profits (and tax liability) through to the owners’ personal tax returns.
• Corporations pay owners through dividends, but the owners aren’t personally liable for the business.
• All business types except sole proprietorship involve legal processes that would benefit from the help of an attorney.

Types of Business Structures

The process of establishing a business depends on the type of structure you choose. Some types of simple establishment processes. Others will take more time, effort, and money. Here are some of the most common types to consider.

Sole Proprietorship

To start a sole proprietorship, all you need is a business license for your city, possibly a “fictitious name” statement, and a business checking account. The sole proprietorship is the default business structure. This means that if you do nothing to register your business as another type, you are automatically a sole proprietorship, particularly for income tax purposes.

Partnership

To start a partnership, you will need an attorney to help you with the partnership agreement and state registration. There are various types of partnerships that you may form, depending on your business and the state in which your business is located.

Limited Liability Company (LLC)

To start a limited liability company, you will need to file articles of organization with your state’s secretary of state to become an LLC. You may be able to do this by filing yourself, or you can get an attorney to help.

Corporation

To start a corporation, you will need to pay an attorney to help you set up your corporation correctly in the state where you will be operating, including a corporate charter and by-laws. Within the category of corporations, you may elect to be a Subchapter S corporation, which has some tax benefits for smaller corporations.

What Happens to the Business If I Am No Longer There?

If you want the business to continue, form a corporation, or put provisions in your partnership agreement or LLC operating agreement to allow the business to continue without you. If you choose a sole proprietorship, there isn’t a business entity that exists separately from you, so the business ends if you leave, die, or can no longer run the business.

How Much Control Do I Have?

Select a sole proprietorship or single-member LLC if you want complete control. In a partnership or multi-member LLC, you will have to share control with your partners (in a partnership) or the other members (in an LLC). In a corporation, you could have a board of directors, shareholders, and others helping you make decisions.

Note

If total control over the business is important to you, don’t incorporate.

Who Receives the Profits and the Losses?

If you want all the profits, you must assume all the losses. Set up as a sole proprietorship or an LLC to keep all the profits (after paying taxes). If you set up a corporation, you will have to give some money to the other shareholders in the form of dividends. If you set up a partnership, you must share the profits with other partners, in a percentage depending on the terms of your partnership agreement. 

Who Pays the Taxes? 

Each business type pays federal taxes differently. Sole proprietorships, LLCs, and partnerships pay taxes on business profits through their personal tax forms. The taxes pass through to the owner personally, so they pay taxes on the profit of the business as pass-through entities.

Corporate owners are shareholders who pay taxes on the dividends they receive. The corporation pays tax on its profit. This is sometimes called double taxation because the owners pay twice (personal taxes on dividends and corporate taxes on business profits).

Do I Need an Attorney to Set up the Business?

If your business is a sole proprietorship, you don’t need an attorney to set it up. All the other business forms require state registration and other agreements and legal processes.

Note

Even if it isn’t strictly required, it’s usually a good idea to get some help from an attorney to be sure all the legal issues are handled correctly.

What Is My Liability as a Business Owner?

As a sole proprietor, you will have all of the business liability for bad debts of the business, as well as for other liabilities, such as negligence, product liability, or professional liability. You can limit your liability by setting up an LLC or, even better, by forming a corporation. Corporations and LLCs are separate entities from your personal financial life, and you may be shielded personally from the liability of the corporation. This is a tricky area, so make sure you understand your liability in each of these forms of business. Find out more from your attorney before you make a decision.

In the end, whatever factors are most important to you will determine the form of business ownership you choose. You may decide to give up control to limit liability, or you may want the benefit of others helping you run the business.

Frequently Asked Questions (FAQs)

What are the most common forms of business organization?

The most common way for businesses to structure themselves is as either a sole proprietorship, partnership, or corporation (including an S corporation).

Which forms of business organization establish a separate legal entity from its owners?

LLCs and corporations each establish a legal entity separate from the company’s owners. This limits their liability, but it can also complicate taxes, such as instances of “double-taxation” with corporations (unless they are S corporations).