The structure you choose for your company will significantly impact your taxes, your liability situation, and many other important aspects of running a business.
Let’s take a look at a few of the most common types of business entities:
Sole Proprietorship
It’s easy to start a sole proprietorship – you don’t have to file any paperwork to register as a sole proprietor or anything like that (though you may have to get a license, depending on what you do). You're automatically a sole proprietor if you charge your clients directly rather than working for a company that charges clients. The owner and the business are the same thing in this situation.
Sole proprietorships aren’t taxed – the owner claims all profits and losses on their personal tax return.
The downside of a sole proprietorship is that it exposes your personal assets to risk if you or your business is sued or takes on substantial debt.
Partnership
Partnerships involve two or more people sharing ownership of a business. Unlike a sole proprietorship, you’ll have to jump through a few hoops to set up this structure. You must register with the state, draft a partnership agreement, and choose a name.
The upside to partnerships is that you have multiple people who can contribute time and money to your organization and help it grow. The downside is that, as a sole proprietor, you’ll be personally responsible for the debt your business incurs.
C Corporation
The “C” in C Corporation refers to the subchapter in the IRS tax code that defines this type of business entity. A C Corporation is like a fake person – it can buy property in its name, sue people, etc. And when a C Corporation is sued, the owner's personal assets are protected in most cases. The owners of C Corporations are called shareholders, as shares of stock represent their ownership.
The disadvantage of C Corporations is that they involve a lot of taxes and paperwork. C Corporations are taxed twice: once for the income that the business makes and then again for the income shareholders make through dividends.
With a C Corporation, you also need to comply with a number of corporate formalities to maintain your business’s status as a separate legal entity. This includes shareholder meetings and board of directors meetings (oh yeah, and you’ll have to elect a board of directors, too).
S Corporation
An S Corporation is similar to a C Corporation in that it’s an artificial person created with state approval to separate its business ventures from its owners' personal lives.
The difference is that S Corporations are structured so that the owners are treated as a partnership for federal tax purposes. This means they don’t have to pay corporate-level taxes, allowing owners to avoid the double taxation that C Corporations face.
This tax advantage is one of the main reasons business owners consider restructuring. If you’re thinking about making the move, take a look at our guide on converting an LLC to S Corp for a full breakdown of what’s involved.
Conclusion
Choosing the proper business structure is key when starting a business. Your business structure has an impact on how much you pay in taxes and whether you qualify for pass-through deductions, and it can also influence how the taxation of stock options applies if you plan to offer equity as part of your compensation strategy.
One thing you'll want to do for sure is to talk with a CPA, such as the professionals at CMP. Do you have any questions about business entity selection? Feel free to contact us by clicking the button below.
