Decide Your Legal Business Structure

When starting your own business, one of the first decisions you’ll make is how to legally structure the business.

There are many different types of legal structures for various business entities. For new business owners, choosing the best one for your business can feel overwhelming.

Don’t rush into making a decision. Instead, spend some time reading about each possible entity your business might fit into. Consider which structure is most helpful for your business, and how each structure can help you accomplish your professional and personal goals.

An LLC (Limited Liability Company), is known as a 'pass-through' entity because the profits of an LLC flow directly to the managers/members.

This type of business structure is quickly becoming the most common form of incorporation. LLCs have a relatively flexible structure that provides many of the benefits of a partnership or sole proprietorship, with some of the protections provided by C corps and S corps (more on those business structures below). They do not require many of the formal processes required by other types of corporations.

However, LLCs are unable to offer stock to the public, have some ongoing annual filing requirements, and are still required to keep internal paperwork.

Importantly, people who ignore the requirements of operating an LLC can lose their personal liability protection, in a process called /piercing the corporate veil'. If this happens, business owners can retroactively be held liable to pay corporate debts with personal funds.

LLCs have the following advantages:

• Liability protection


• Easier process for setup


• Easier to maintain


• Flexibility on taxes and management

LLCs have the following disadvantages:

• Self-employment taxes (unless an S corp election is made, as described below)


• Difficulty attracting investors for funding


• Added formation costs and franchise tax in some states

C corp is what most people think of when they hear the word 'corporation'. Most large companies are filed under this structure, as it offers the most asset protection and tax-related options for business owners. It is also typically the only choice for owners that would like to be taxed separately from their company, is the legal entity preferred by nearly all investors, and is the most common structure for publicly-traded companies on the stock exchanges.

But, a C corp structure isn’t the best choice for everyone. Filing as a C corp requires a greater amount of paperwork, as well as formal processes that must be carefully and regularly filed. C corps are often also more closely monitored than other types of businesses, due to the fact that they are one of two types of corporations that can issue stock to the public.

C Corps have the following advantages:

• Ability to take the company public and issue stock


• More attractive structure for investors


• Liability protection


• A possible lower tax rate

C corps have the following disadvantages:

• Double Taxation (company and personal income; more on that below)


• Extra paperwork


• Strict regulation

Many people don’t know that LLCs can also make S corp elections.

After reading the prior section, you may wonder why an LLC would make that election given the primary benefit double-taxation avoidance with a pass-through entity is already the default for an LLC. Yet, an S corp election for an LLC can also provide additional tax benefits to an LLC.

By making an S corp election, the LLCs distributions (the passing of profits after payment of LLC expenses including payroll) are not treated or taxed as wage income to the owners.

Let’s say, for example, that you own an LLC and the annual profits are $1M. Without an S corp election, the owner of the LLC would have to pay payroll taxes on the $1M worth of profits. With an S corp election, the LLC owner would pay taxes on the $1M worth of profits. With an S corp election, the LLC owner only pays payroll taxes on a 'reasonable' salary that gets paid to the owner. Any distributions after the payment of a reasonable salary are free of those payroll taxes if done correctly.

The same restrictions described above applicable to corporations also apply to LLCs, so there are some restrictions on an LLC that makes an S corp election. Also, if the owners aren’t paid reasonable salaries, the IRS can invalidate the S corp election requiring the payment of back taxes and penalties.

>S corp election for LLC advantages:

• All the benefits of an LLC


• A possible lower tax rate by avoiding some payroll taxes for the owners

S corps election for LLC disadvantages:

• Limited ownership rules


• Extra paperwork


• Strict regulation


• Penalties if not properly implemented

A sole proprietorship is the default type of entity when a business is started by one owner. Unlike LLCs or Corporations, states do not require you to file your business initially or file periodic reports if you want to operate a sole proprietorship. The downside is that the owner is held liable for all losses, legal issues, and/or debt that the business accrues. There is little-to-no distinction between the entity and the business owner.

Examples of Sole Proprietors include freelancers, artists, consultants, virtual assistants, and other home-based owners who have not formally registered as an LLC or corporation.

Sole proprietorship advantages:

• Easy set-up with low fees and little paperwork


• Flexible management structure

Sole proprietorship disadvantages:

• Personal liability for all debts, legal obligations, and losses of the business


• More difficult to raise capital


• No ongoing business life (business ends with the owner)


• May not have access to certain tax benefits

Many sole proprietorships and general partnerships (as well as other business entities) still want to operate under a business name. To do so, they should file a DBA (Doing Business As) with their local state or county. Here are the DBA requirements in all 50 U.S. states and territories.