Business Structure Types: A Business Structure Chart

The general definition of business structure is the kind of relationship the owner has with his or her business. In other words, this is the legal relationship between the business owner and the business itself and affects how the owner files taxes. In a sole proprietorship, for example, the owner and the business are one entity and thus only one tax form is required. Conversely, in a corporation, the owner and the business are separate entities. As such, the owner and the corporation must file taxes separately.

The chart below outlines the different business structures that you can use for your business. This chart presents business structure basics. For most people, the primary consideration when picking their business structure is money - how much will filing for an LLC cost? Or does a DBA cost anything?

Many small business owners make the mistake of over-looking liability. Some business structures protect you, the owner, from personal liability (as long as you do not abuse those rights of course), while others do not offer such liability protections. As a small business owner, you should sit down and really think about the potential of you being sued. If you are running a brick and mortar store, then you are more likely to be sued than someone who is selling their items online and is not inviting customers into a physical location. If you are running a day care center from your home, than you are more likely to be sued than someone who makes children's clothes. So, really give this some thought. If you decide that you are in a position where someone will likely sue you, then do not risk your personal assets. Spend the few hundreds dollars now (and in some states the LLC filing fee is as low as $100) and get an LLC or incorporate.

Business Structure Advantages and Disadvantages of Business Structures
Sole Proprietorship Pros of Sole Proprietorships
  • Sole proprietorships are easy to set up and easy to disband. Generally, business registration is not required. But, to get a bank account and to have others treat you as a business, you will likely need to get a DBA (doing business as) or Fictitious Business Name from your local county or state secretary of state
  • Not required to file formation documents as you are with an LLC for example
  • Easier bookkeeping because the owner and business are treated as one entity (but - you should still keep separate records for your business as the IRS does audit sole proprietors)
  • Profits are taxed at the owner’s individual federal tax rate so the owner does not need to file additional corporate paperwork as is necessary with the corporate business structure
  • Sole proprietorships do not file corporate income tax returns

Cons of Sole Proprietorships

  • The primary disadvantage of the sole proprietorship business structure is liability--the owner's personal assets are not protected because the company and the individual are treated as one entity

Business structure example: anyone who runs their own business who did not incorporate, file for an LLC or is in a partnership. This often includes anyone who receives a 1099 rather than a W-2. For example, many crafters are sole proprietors (but they do have state tax ids because any small business selling products must collect sales tax).

Partnerships There are several partnership structures: General Partnership, Limited Partnership and Limited Liability Partnership.

Pros of General Partnerships

  • Partnerships can be easily formed because, similar to sole proprietorships, these business entities are unincorporated
  • Partnerships allow two or more people to share liability and provide capital
  • Business income is reported on partners’ individual tax returns

Cons of General Partnerships

  • The primary disadvantage of the sole proprietorship business structure is liability--the owner's personal assets are not protected because the company and the individual are treated as one entity
  • Note, this can be overcome to some extent by using the limited partnership structure. BUT, there must always be a general partner who shoulders all the liability
  • All partners are liable jointly and severally for all obligations of the partnership unless agreed by the person suing the partnership or the partner

Limited Partnership: The Limited Partnership business structure may provide limited liability for some partners. There must be at least one general partner that acts as the controlling partner and one limited partner whose liability is normally limited to the amount of control or participation of the limited partner. General partners of a Limited Partnership have unlimited personal liability for the partnership's debts and obligation. To form a Limited Partnership, the members must usually file a Certificate of Limited Partnership with the Secretary of State.

Limited Liability Partnership: The LLP business structure is generally reserved for a group of accountants or lawyers. LLPs must register with the state. Generally have to file paperwork yearly and pay LLP fees.

Business structure example: Two people who work together who contribute to the enterprise are partners if they both agreed that they will put something of value into the business and get something out of the business. They share the profits and losses of the business. People who are partners know they are in a partnership. Generally, these partners have a formal agreement but an agreement is not necessary to have a partnership. Most law firms and accounting firms are partnerships.

Limited Liability Company Pros of LLCs
  • The primary advantage of LLCs is that they offer liability protection similar to that of a corporation
  • Can be created with one person as a member (unlike partnerships which require at least two people)
  • The company owner can choose how the LLC should be taxed - either like a partnership or sole proprietorship where the owner is taxed at the individual level (i.e., just file you individual taxes and claim your business expenses on you individual form) or like a corporation where the owner files a separate tax statement for the LLC. The IRS calls this option the check the box rule and pass through taxation.

Cons of LLCs

  • Must file documents with the Secretary of State
  • Must file Articles of Organization with the Secretary of State
  • Must draft an operating agreement that servers as the agreement among the members which describes the affairs of the LLC and the conduct of the business (may have to file this with the State but generally needs to keep a copy along with the LLC's records)
  • Must pay yearly fees to renew the LLC and file specific paperwork yearly

Business structure example: LLCs must display the LLC after the name of the business. This shows the public that the business owners enjoy limited liability. Some large LLCs include Marathon Petroleum Company LLC and Chysler Group LLC.

Corporations Pros of Corporations
  • A corporation is a legal entity that exists separately from its owner(s)
  • The owners of the corporation enjoy limited liability. That is, owners of a corporation are not personally responsible for the debts of the corporation
  • Can sell stocks and bonds which can generate additional capital
  • The Corporation can continue past the death of the owners
  • Ownership is easily transferable through the sale of stock
  • Fringe benefits

Cons of Corporations

  • The primary disadvantage of the corporate form is double taxation: the corporation pays taxes on any income and then when the corporation pays dividends to the owners (the shareholders), they also pay taxes on those funds
  • Must file Article of Incorporation with the Secretary of State
  • Must file paperwork with the Secretary of State every year and pay corporate filing fees

There are different forms of corporations including the C-Corp and the S-Corp. The subchapter C corporation has double taxation. The subchapter S corporation can receive pass through taxation treatment. But, the S-Corp. has other limits such as the number of shareholders. Please check the IRS website for the specific limitations.

Business structure example: Most Fortune 1000 businesses are incorporated. They can be either closely held or publicly traded. Examples include P&G, Johnson & Johnson, Wal-Mart, and Microsoft.

This article attempted to answer and provide information on the following the following: Business structure types; Business structure comparison; Business structure chart; Business structure definition; Business structure pros and cons; Business structure example.

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