Whenever I speak at events for entrepreneurs, the question that I am inevitably asked is, “What type of business entity should I use for my business?” Simply put, there is no simple answer, as each type of entity has its advantages and disadvantages depending on what the owner(s) is trying to accomplish.
The purpose of this article is to provide an overview of the most popular business structures- but, I must emphasize that you should discuss the issue in more detail with your lawyer and tax advisor before making any permanent decision.
The simplest business structure is a sole proprietor. There is one owner and that one owner runs and manages the business. The individual personally contributes the money to operate the business and any profits earned are taxed on the sole proprietor’s personal tax return. While this is the simplest structure, it also carries with it the largest downside; unlimited personal financial liability. For this reason alone, I caution against this structure.
Similar in some respects is the S Corporation (“S Corp”). The S Corp allows many (but not more than 100) shareholders, and issues only one class of stock. Management of the S Corp resides in the board of directors and the officers have the day-to-day operations responsibility. Like the sole proprietorship, profits pass through to the shareholder’s personal tax return but are not taxed again at the corporate level. Unlike the sole proprietorship, in most cases, there is no unlimited personal financial liability, and the financial liability is limited to the amount of money invested to purchase the shares of stock.
A limited liability company (“LLC”) is very similar to an S Corp. Other than the different terms used with an LLC such as members instead of shareholders and units instead of stock, the most significant differences is that an LLC can have an unlimited number of members and those members may be individuals or other business entities.
The final business structure is the C Corporation (“C Corp.”). A C Corp is most similar to an LLC but differs in two very important respects. First, a C Corp may issue more than one class of stock. Second, a C Corp is taxed on two levels; the corporate level and the personal level. The major companies that you hear about on the news are typically C Corps.
As you can see, there are a lot of options, each of which has its own advantages and disadvantages. Discuss the matter with your lawyer and tax adviser and determine which is the best business structure for your business.