The legal structure of a business is an important decision that can have long-term implications. It affects everything from the taxes the business pays to the degree of personal liability the owners have. There are a variety of legal structures to choose from, each with its own advantages and disadvantages.
From sole proprietorships and partnerships to LLCs and corporations, there are many options to consider. Understanding the pros and cons of each structure can help business owners make the best decision for their business.
A sole proprietorship is an unincorporated business owned by one individual. A sole proprietorship is the simplest type of business to start and run since it does not have to file special paperwork with the government.
In return for its simplicity, a sole proprietorship has very few formalities or legal protections. The owner and the business are treated as one and the same. This means that if the business is ever sued, the owner’s personal assets, such as their house or car, are at risk. However, it also means the business does not have to pay taxes on its profits.
A partnership is a business owned by two or more people. Partnerships are easy to set up and can be attractive to start-ups, given the lack of red tape and government oversight. Unlike a sole proprietorship, partners in a partnership are legally separate entities. This means that if the business is ever sued, only the partnership’s assets are at risk, not the partners’ personal assets.
Partnerships, however, are not very common. This is because they lack the formalities and legal protections of other business structures, such as limited liability companies. In return for these benefits, partnerships must file special paperwork with the government and are required to distribute profits to partners based on their contributions to the business.
Limited Liability Company (LLC)
An LLC is a hybrid between a sole proprietorship and a corporation. It is owned by one or more individuals but is treated as a distinct legal entity by the government. This means that the owner’s personal assets are not at risk if the business is ever sued. Like corporations, the owners of an LLC are subject to ownership restrictions.
For example, no one person can own more than 50% of the company. LLCs have many tax advantages, including the ability to pass profits and losses through to owners and to be treated as corporations for tax purposes. The major potential drawback of LLCs is high start-up costs due to government red tape and formalities. For example, LLCs are required to file special paperwork and pay taxes as corporations.
A C-corporation is a distinct legal entity owned by shareholders. Like an LLC, C-corporations have numerous tax advantages, including the ability to pass profits and losses through to shareholders and to be treated as corporations for tax purposes.
The major potential drawback of C-corporations is that they are subject to strict corporate formalities and are also heavily regulated by government agencies like the Securities and Exchange Commission (SEC).
For example, C-corporations are required to have directors, hold shareholder meetings, and file regular public reports. For these reasons, C-corporations are often reserved for larger businesses. In return for the benefits, shareholders must pay taxes on their earnings as if they were an employee.
S-corporations are C-corporations owned by one individual who assumes all of the business’s legal and financial risk. S-corporations have the same tax advantages as C-corporations but with fewer formalities and government oversight.
For example, S-corporations are not required to hold shareholder meetings or file regular public reports. In return for the benefits, shareholders must pay taxes on their earnings as if they were an employee. S-corporations are best for start-ups and small businesses that want the tax advantages of a C-corporation without the heavy red tape and government oversight. S-corporations are also a popular legal structure for co-ops and other non-profit organizations.
B-corporations are a new hybrid structure that attempts to marry the best of corporations and non-profits. B-corporations are owned by shareholders and have all of the tax advantages of C-corporations. However, B-corporations are also required to demonstrate a positive impact on society and the environment. B-corporations have additional government reporting requirements similar to non-profits. For example, B-corporations must report on their positive impact and progress toward social and environmental goals. B-corporations are a relatively new legal structure and have not been tested in court. This makes it unclear what legal protections are for shareholders. For this reason, B-corporations are best for large businesses that want to impact society and the environment.
Non-profits are distinct legal entities owned by one individual or a small group of people. Non-profits are required to be run as a business with a positive impact on society and the environment. Unlike B-corporations, non-profits are not required to distribute profits or have a profit-making purpose. The major drawback of non-profits is that they have very few legal protections.
For example, non-profits are not allowed to distribute profits as dividends and are not taxed on profits. This means that non-profits are best for charities and non-profits with very little revenue. If a non-profit ever grows large enough to be a significant revenue source, it will have to restructure as a different legal structure.
The legal structure of a business is an important decision that can have long-term implications. It affects everything from the taxes the business pays to the degree of personal liability the owners have. There are a variety of legal structures to choose from, each with its own advantages and disadvantages. Understanding the pros and cons of each structure can help business owners make the best decision for their business.