Choosing the Best Ownership Structure for Your Business
When you start a business, you must choose an ownership structure for it -- for example, whether it will be a
sole proprietorship, partnership, corporation or limited liability company (LLC).
There's no one choice that fits every business; your job is to pick the form that best meets your needs. This
article introduces several of the most important factors involved in picking the right legal structure for your
business, including:
•
•
•
•
the potential risks and liabilities of your business
the formalities and expenses involved in establishing and maintaining the various business structures
your income tax situation, and
your investment needs.
Risks and Liabilities
In large part, the best ownership structure for your business depends on the type of services or products it will
provide. If your business will engage in risky activities-- for example, trading stocks or repairing roofs -- you'll
almost surely want to obtain liability insurance and form a business entity that limits personal liability, which
can shield your personal assets from business debts and claims. However, please note that it is quite common
that vendors require personal guarantees from the owners/management of companies during their formative
years.
Formalities and Expenses
Sole proprietorships and general partnerships are easy to set up because you don't have to file any special forms
or pay any fees to start your business. Plus, they don't require you to follow any special operating rules.
LLCs, corporations, and Limited Liability Partnerships (LLP) on the other hand, are not as easy to set up, but do
offer added potential benefits. To form an LLC, corporation, or LLP, you must file a document with the state
and pay a fee. In addition, owners of corporations and LLCs must elect officers (usually, a president, vice
president and secretary) to run the company, and they must keep records of important business decisions and
follow other formalities.
Income Taxes
When it comes to taxes, sole proprietorships, partnerships and LLCs that are taxed as partnerships come out
about even. These three business types are "pass-through" tax entities, which means that all of the profits and
losses pass through the business to the owners, who report their share of the profits (or deduct their share of the
losses) on their personal income tax returns. Therefore, sole proprietors, partners and LLC’s taxed as
partnership owners can count on about the same amount of tax complexity, paperwork and costs.
1000 Heritage Center Circle, Round Rock, TX 78664
512-368-7202
www.centexbusinesslaw.com
One thing to bear in mind is that owners of these businesses pay income taxes on all net profits of the business,
regardless of how much they actually take out of the business each year. Even if all of the profits are kept in the
business checking account to meet upcoming business expenses, the owners must report their share of these
profits as income on their tax returns.
Generally speaking, the owners of a corporation do not report their shares of corporate profits on their personal
tax returns. The owners pay taxes only on profits paid out to them in the form of salaries, bonuses and
dividends. However, corporations that elect to be taxed under Subchapter S of the tax code, and LLCs that
make this similar election, file an informational type return with the actual profits and losses being reported on
the owner’s individual tax returns.
The corporation itself pays taxes, at corporate tax rates, on any profits that aren't deductible -- that is, profits
that are left in the company from year to year (called "retained earnings") and dividends (portions of profits that
corporations sometimes pay out to shareholders in return for their investments). This separate level of taxation
adds a layer of complexity to filing and paying taxes, but it can be a benefit to some businesses.
Investment Needs
Corporations -- unlike other types of business structures -- provide a built-in stock structure that makes it easier
to attract investment capital, including the possibility of raising capital by making an offering of shares. In
addition, this stock structure allows businesses in the Internet and other hot technology industries to attract and
retain key employees by issuing employee stock options.
However, corporations that elect to be taxed under Subchapter S do face some key restrictions when it comes to
investment options. The two major differences between an S Corporation and C Corporation from an
investment perspective are: 1) an S Corporation can only issue one class of shares – meaning that all shares are
equal; and, 2) other than a few exceptions relating to trusts, shareholders must be residents or citizens of the
United States.
But for businesses that don't need to issue stock options, do not foresee "going public," forming an LLC may be
more practicable. If limiting liability is the goal, an LLC may provide the same protection as a corporation, but
provide you with more flexibility from an operational perspective.
Conclusion
As you can see, when deciding which entity to choose, the key decision making points come down to which
issue is more important – limiting taxes, or limiting liability. The chart on the next page summarizes some of
the major advantages and disadvantages of the different entity to help make comparison easier.
1000 Heritage Center Circle, Round Rock, TX 78664
512-368-7202
www.centexbusinesslaw.com
Which Legal Entity is Best for Your Business?
Type of Entity
Main Advantages
Main Drawbacks
Sole Proprietorship
Simple and inexpensive to create and operate.
Owner personally liable for business debts.
General Partnership (GP)
Owner reports profit or loss on his or her personal tax
returns.
Simple and inexpensive to create and operate.
Owners (partners) personally liable for business debts.
Limited Partnership
(LP)
Limited Liability Partnership (LLP)
Owners (partners) report their share of profit or loss on
their personal tax returns.
Limited partners have limited personal liability for
business debts as long as they don’t participate in
management.
General partners can raise cash without involving outside
investors in management of business.
Mostly of interest to partners in old-line professions such
as law, medicine and accounting.
General partners personally liable for business debts.
More expensive to create than GP.
Suitable mainly for real estate investment companies.
Unlike a LLC or a PLLC, owners (partners) remain personally
liable for many types of obligations owed to business creditors,
lenders and landlords.
Owners (partners) aren’t personally liable for the
malpractice of other partners.
Limited to a short list of professionals.
Owners report their share of profit or loss on their personal
tax returns.
Owners have limited personal liability for business debts.
More expensive to create than partnership or sole proprietorship.
Fringe benefits can be deducted as business expense.
Paperwork can seem burdensome to some owners.
Owners can split corporate profit among owners and
corporation, paying lower overall tax rate.
Owners have limited personal liability for business debts.
Separate tax entity.
Owners report their share of corporate profit or loss on
their personal tax returns.
Income must be allocated to owners according to their ownership
interest.
Professional Corporation (PC)
Owners can use corporate loss to offset income from other
sources.
Same as corporation (S or C Corp)
More expensive to create than partnership or sole proprietorship.
Nonprofit Corporation
Owners have no personal liability for malpractice of other
owners.
Corporation doesn’t pay income taxes.
Regular Corporation
(C Corp.)
S Corporation (S Corp.)
More expensive to create than partnership or sole proprietorship.
All owners must belong to the same profession.
Full tax advantages available only to groups organized for
charitable, scientific, educational, literary or religious purposes.
Contributions to charitable corporation are tax-deductible.
Limited Liability Company (LLC)
Fringe benefits can be deducted as a business expense.
Owners have limited personal liability for business debts
even if they participate in management.
Profit and loss can be allocated differently than ownership
interests.
Professional Limited Liability
Company (PLLC)
IRS rules now allow LLCs to choose between being taxed
as a partnership or corporation.
Same advantages as a regular LLC.
Gives state licensed professionals a way to enjoy those
advantages.
Property transferred to corporation stays there; if corporation
ends, property must go to another nonprofit.
More expensive to create than partnership or sole proprietorship.
State laws for creating LLCs may not reflect latest federal tax
changes.
Same as for regular LLC.
Members must all belong to the same profession.
1000 Heritage Center Circle, Round Rock, TX 78664
512-368-7202
www.centexbusinesslaw.com