Choosing the right business structure is an important decision. But how do you know which business structure is the right one for your small business? Choosing a business structure depends on your small business goals and your tax situation. This decision impacts everything from your day to day operations to how much of your personal assets are at risk.
The range of business structures varies, but the three you’re likely considering are a sole proprietorship, limited liability company, or S corp. All three of these business structures are pass-through entities, meaning that the business does not pay income tax of its own. Instead, the income, losses, credits, and deductions “pass-through” to each business owner’s personal tax return, where its profits are taxed according to each owner’s individual income tax rate.
Let’s take a closer look at each of these three popular business structures and see which one best suits your small business’s needs:
Sole proprietorship
A sole proprietorship is easy to form and gives you complete control of your business. You’re automatically considered to be a sole proprietorship if you do business activities but don’t register as any other kind of business, so if you’re already in business, you are likely already a sole proprietorship! As a sole proprietor, you are liable for all business debts and liabilities, and you report all business income and losses on your personal tax return. It can be difficult to secure funding with this business structure, as some financial institutions are wary of lending to sole proprietorships, but forming a sole proprietorship is a good choice for low-risk businesses or owners who want to test out their business idea.
Limited liability company or LLC
An LLC takes a little more effort to form than a sole proprietorship, but don’t worry, it’s still relatively easy to set up. An LLC is a popular choice for small businesses because it offers limited liability protection, protecting the owner’s personal assets from business debts and liabilities. Forming an LLC usually involves filing and renewal fees, so there’s a little more maintenance involved, and you might be subject to higher self-employment taxes. An LLC is a great option for small, but growing businesses or higher risk businesses because the separate legal identity offers liability protection as well as flexibility in management structure.
S corporation or S-corp
Big companies are usually C-corps, but the small business version is an S-corp. The S stands for subchapter S corporation, but you can think of it as a small business corp. Small business owners often prefer S corp. taxation because their profits aren’t taxed at the higher corporate level. S-corps provide the benefits of protected assets and reduced self-employment tax liability, but they are in turn more costly to form and maintain, less flexible, and subject to closer scrutiny by the Internal Revenue Service. An S-corp is a great option for a small business with more than $40,000 in profit due to the significant savings on self employment taxes.
Bottom Line
Whether you choose a sole proprietorship, LLC, or S-corp, you’ll have to consider liability protection, tax implications, formation and maintenance, as well as what level of control you want to have over your business. The best way to decide which business structure is right for you is to consult an expert. An attorney or tax advisor with experience in business structure formation can help you assess your specific situation and make a recommendation based on your individual needs.
Please note that this information is not intended to be a substitute for legal or tax advice. You should always consult with a qualified professional before making any decisions about your business structure.
