How To Choose The Best Legal Structure For A Business

So you want to be an entrepreneur. You have an idea that you want to turn into a business venture. Of course, that’s a lot of work. One of the biggest work is to determine the legal structure of your company. All the legal terms and jargons, it’s so confusing, especially if you are a beginner, right?

That’s why in today’s article, I will help you with that. I will talk about the different company legal structures, their description, and their pros and cons. So, let’s get started.

Choose Best Legal Structure For A Business

Types of Legal Structures:

In this article, I will talk about the five most seen legal structures for any business. I will discuss their main points, pros, and cons in detail. Once you finish reading the post, you will have a clear idea of all of them.

Sole Proprietorship:

Sole Proprietorship is a structure where you are the only owner and operator of your business. This is the easiest and most informal business legal structure.

Single Owner and Operator:

This type of business structure has only one owner who operates the whole business by himself or herself. They are entitled to hire employees, but not partners.

Informal Incorporation:

Sole Proprietorships are the most informal business structure. They are not incorporated as a corporation or partnership.

Tax Identification:

You can file taxes with your social security number if you are the only employee. You will need an Employment Identification Number or EIN from the IRS only if you hire employees.

Pros:

  • It is the simplest form of business legal structure
  • You don’t need to give taxes as a businessperson and then again as an ordinary citizen

Cons:

  • Only you are responsible for the losses, debts, and obligations of the business
  • It is hard to get loans unless you have a collateral

Partnership:

In a partnership, there are two or multiple people who are the owners of the business. This is also an informal legal structure of a business. There are usually three kinds of partnerships.

General Partnership:

A general partnership is the simplest form of partnership. In this kind of partnership, all of the partners have equal voting rights, equal share in profits and liabilities, and are responsible for an equal amount of duties.

Limited Partnership:

In a limited partnership, which is also named limited liability partnership, the people categorized as ‘limited partners’ has very little control. They basically are investors on the business in a passive way. They do not control any day to day activity or decisions of the company, neither they have any share in debts or liabilities. They receive profit as per the interest of their investment.

Joint Venture:

A joint venture is best suited for projects that need multiple resources. A common example is the real estate business.

Pros:

  • Resources and responsibilities are shared among two or more people, making them easier to bear
  • A person can quit from a partnership anytime he or she wishes, depending on the rules and regulations
  • Taxes are borne by each partner equally, making it less of a burden on any single person

Cons:

  • A share of liability as per the interest of the investment falls on each partner
  • The success of the partnership is dependent on the relationship with your partner

Corporation (C-Corp):

A Corporation interchangeably called as C Corporation or C Corp is a legal entity which is owned by its shareholders. This is a formal business structure.

Formal Structure:

Any corporation has to be incorporated with the state business authorities. Filing articles of incorporation are mandatory in this business legal structure.

Operating Agreements:

Operating agreements contain the specific ways the company should be handled. This is not mandatory, but it is highly recommended to have one. These are also called bylaws.

Tax Filing:

Corporations are treated as different legal entities from their shareholders. A corporation is bound to pay state, federal, and often local income taxes. These taxes are charged at a corporate rate, which is different from the personal income tax rates.

Pros:

  • The owners are liable for a very small amount as corporations are separate legal entities
  • Capitals and loans are easier to generate
  • They are more trustworthy to everyone than sole proprietors

Cons:

  • They are double-taxed, once from the corporation, and another from the shareholder’s personal income
  • These are expensive and requires a lot of work to form

S Corporation (S Corp):

The S Corporation or S Corp is a business legal structure that is perfect for small to medium sized business. These are more complex in nature than C Corps.

Election:

The shareholders must sign and file IRS form 2553. This has to be complete before the tax year or within 75 days from its beginning.

Shareholder Restrictions:

S Corps can have no more than 100 shareholders. Making things even more complex, all the shareholders have to be a US citizen.

Stock Restrictions:

S Corps are only entitled to issue common stocks. No preferred stocks can be issued by them.

Pros:

  • S Corps also generate limited liability to its shareholders
  • No double taxation are subjected to S Corps
  • It’s easier to raise capital and loans through S Corps

Cons:

  • No more than 100 shareholders can be present
  • Record keeping and regulations are such a huge burden in this business legal structure

Limited Liability Company (LLC):

A Limited Liability Company or LLC is the most recent legal structure for business. It’s also the one with the most flexibility.

Tax Treatment:

LLCs are categorized as corporations, partnerships, and sole proprietorship for tax purposes depending on their structure. Tax rates vary as per their categorization. It ranges from personal income tax rates to double taxation and corporate level tax rates.

Formal Incorporation:

LLCs need to be incorporated formally. It is usually filed to the appropriate state authorities. However, it has a lesser regulation than C Corps and S Corps.

Pros:

  • Record keeping and regulations are lesser than C Corp and S Corp
  • Besides humans, any corporation can be a shareholder as well
  • If it’s treated as a sole propriety, LLCs can get rid of double taxation

Cons:

  • The employers are tagged as self-employed
  • Double taxation can result if the LLC is categorized as a corporation

So these are five most seen legal structures for any business. I hope the article was enjoyable and helpful. Thanks for reading!

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