How to Choose the Right Legal Entity for Your Business

JP Morgan Chase mentions that a large volume of small businesses is relatively new. Part of surviving in a competitive field such as new business comes from having a competitive product and a great marketing team. The other part of it comes from knowing the most beneficial method of structuring your business. A business structure is such an essential part of companies, yet so many new business owners overlook it. As The Balance SMB mentions, the most common type of business structure in the US is the sole proprietorship. This prevalence isn’t because of any special protections that sole proprietorship brings to the table, but because it’s the simplest and most comfortable thing to get yourself set up as an entrepreneur as quickly as possible.

Business owners should be aware of their options when it comes to business structure. Just because a business structure is easy to set up makes it ideal for your company. From both an ownership and a tax perspective, the type of business you set up could help you manage your business and personal assets and finances. This article will help you understand the major types of business structures and what they’re best used for.

Three Distinct Types of Business

Small businesses can come in any type of industry. However, regardless of the industry, each company can be categorized as one of three. However, just breaking them down into their names will do little to dispel the mystery behind what they do. If you look at the business structure from a practical perspective, it begins to make more sense why these particular business structure categories exist. The thing business owners should ask is, “What would I like my business to do for me?” The three types of business structure that you’re most likely to encounter are:

1. Sole Proprietorship

As we mentioned before, a sole proprietorship makes up the majority of small businesses in the US. Entrepreneur notes that a sole proprietorship isn’t a legal entity, just an individual who runs a business and takes full responsibility for its debts and liabilities. Because sole proprietorships are so easy to set up, they’re the number one type of business entity in the country. A man with a shingle and dream can own a sole proprietorship, selling goods and services from the back of his van.

Despite its simplicity, sole proprietorships have several things working against them. A sole proprietor gets no tax benefits, no asset protections, and no estate planning benefits. They can set up shop and shut down anytime they feel like it without filing complicated legal papers. But if their business is taken to court, they stand to lose everything if the decision goes against them. Sole proprietorships are cheap and straightforward. They have very little else to recommend them as a business structure.

2. Partnerships

Partnerships are typically two or more people or companies getting together to do business. They can be defined as limited or general partnerships. These partnerships are legal entities and offer a certain level of protection for the members. The most popular type of partnership is known as a limited liability company or LLC. In the past, LLCs required a minimum of two people to operate, but new legislation has accepted the formation of single-member LLCs. LLC’s offer a significant number of benefits for its users.

Firstly, LLCs themselves have no federal tax rating, and as a result, they’re dealt with using pass-through taxation. This designation means that the LLC isn’t taxed, but individual members pay taxes based on the amount they make through the LLC. LLCs also offer asset protection for members. If the LLC is involved in a legal matter, the owners’ assets can’t be part of the settlement.

3. Corporations

Corporations aren’t always the massive, multinational, sprawling business entities you think of. Any business can operate as a corporation. Individuals who are professionals such as dentists, doctors, or lawyers could run their businesses are corporations. While there are several different categories of corporations, you don’t need to consider all of them. You can simply think of them all as regular corporations.

Most Common Business Structure Options

As we mentioned before, these business structures are broad categories that can be further distilled into a format that fits your company. Among the most commonly created business structures are:

Limited Liability Companies (LLCs)

A strict upgrade to the sole proprietorship, an LLC offers you flexibility and useful asset protections at the drawback of being slightly more complicated. The legality of incorporating an LLC serves to protect your interests and keeps you tax-compliant. There are some shortcomings in the protections that an LLC offers to its members. Members of an LLC are protected from putting their own assets on the line of the business does any wrongdoing. However, LLCs don’t protect an individual from personal liability that may result from failure to deliver a service—knowing that the protections that an LLC offers you only extend so far makes you aware that owning an LLC doesn’t make you invincible.

S-Corp

S-Corps technically only exists as a designation for an LLC. They are not real legal entities but are a category that the IRS can use to tax the company. Since LLCs themselves don’t have a tax designation, choosing to have the business taxed as an S-Corp allows you to skip a high corporate tax that might be attached to the other type of corporation, a C-Corp. Additionally, you can separate your roles in the company as both an employee and a business owner. You can then pay yourself a salary that’s taxed at the regular rate and gain profit distribution from the business as an owner that doesn’t have that salary taxation attached to it.

A Difficult Choice

It’s true that determining what’s best for your company comes with figuring out what you want out of the business structure. Sole proprietorships are quick and straightforward but don’t offer you any other benefits. LLCs offer you a limited set of protections and the ability to deal with taxes creatively. S-Corps give you a chance to operate as both an employee and a business owner within the same entity and reap the beneficial tax rates of being both. Knowing your goal will help to inform you which company structure is most suitable for your business.

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