There is a multiplicity of options to consider when opening a business, but there will only be one right answer for how to structure your entity – this is because each entity type comes with different benefits and requirements. Each type of entity will imbue your organization with a different character, not to mention determine how much it pays in taxes, who is liable for different legal aspects, how and when you can raise money, and even what documents are required to be compliant in running the business. While the business entity structure is not the only determinant in these processes – location, stakeholders and industry all play key roles as well – it is the most important one. This guide is not intended as advice to help you establish your business, but as a jumping-off point for the larger conversation you should be having about how to structure your business. Keeping that in mind, here is a discussion of four business entity categories to explore when deciding how to structure your business.
The Different Business Entity Structures
Entity Structure #1: Sole Proprietorship
In many ways, a sole proprietorship is the most uncomplicated option for opening a business. It is best for small businesses with only one interested party running the operation. It is the most common business entity structure, and tends to have the least amount of paperwork involved. These businesses can be owned by a single individual or a married couple, jointly. The main drawback is that there is no separation of the owner from the liability of the business, meaning that the owner is responsible for any legal or financial penalties that are levied on the business, as well as taxes.
Entity Structure #2: Partnership
Partnerships involve two or more individuals who agree to be liable for the losses of, or share in the profits of a business venture. Without getting too much into the weeds, there are generally four types of partnerships. General partnerships are the least formal, and consist of any unincorporated businesses. Limited partnerships are incorporated businesses with both limited and general partners. General partners take part in the day-to-day operations, whereas limited partners tend to be more passive in the business operations, i.e., they act as investors.
Limited liability partnerships (LLPs) and limited liability limited partnerships (LLLPs) have a lot of overlap in that they both provide greater liability protection for the partners involved, with LLLPs providing less liability protection for certain partners. If you expect to have many passive investors, one of the limited partnership options (LP, LLP, LLLP) is probably the best option here. The main benefit of a partnership is that the taxes on any profits or losses are “passed through” to the individual owners and when they file their individual tax returns, they report the income there. This means more profits up front.
Entity Structure #3: Limited Liability Company
Limited Liability Companies (LLCs) and Professional Limited Liability Companies (PLLCs) are the intermediate step between a partnership and a corporation. They offer both the “pass-through” taxation that is so beneficial in partnerships as well as the greater liability protection that exists in corporations. There are certain drawbacks to this, as these organizations are – depending on jurisdictional law – sometimes mandated to dissolve upon the death of a partner. PLLCs are a special form of LLCs for professionals such as doctors or dentists.
Entity Structure #4: Corporation
A corporation is the most complex form of business entity structure we have discussed so far, and as such, the most expensive to arrange. They are completely separate, legally speaking, from their investors. This engenders an incredible degree of protection in terms of liability for those who create the corporation, but also means that there is a greater number of tax and regulatory issues with which to deal.
Corporations are responsible for their own debts, and thus, the owners assume no risk to their own personal assets. The costs associated with a corporation are due largely to operations and taxes. The business operations involve a much heavier load of accounting and regulatory/compliance resolution, as they are incorporated within a certain state and must navigate the laws of that state. The burden of taxation on corporations is much higher because corporations must pay taxes, and the profits paid to shareholders are also taxed on their individual tax returns. Depending on the structure of the corporation, sometimes the individual taxation can be avoided by paying profits as salaries, as corporations are not required to pay taxes on profits dispensed as reasonable compensation, although these are muddy waters given how the Internal Revenue Service (IRS) defines “reasonable,” and should be navigated with the help of a legal expert.
The most popular form of corporation is an S corporation, due to its structure. An S corporation provides the protection of the corporate veil with tax benefits more akin to a partnership, with income and losses being passed through to individual shareholders to be reported on their tax returns. A C corporation, or standard corporation, is much more – well, corporate, for lack of a better word. It is composed of shareholders, directors and officers. The tax benefits of a C Corporation can be split between the shareholders and the corporation, resulting in a friendlier tax bill on the whole. C corporations can also deduct certain expenses such as employee benefits like health insurance plans.
Complex entity structures require adaptable entity management systems
The more complex the business entity structure gets, the more complex the documentation gets. The needs of a business with many different interests across multiple industries are too much to document in the old-fashioned way, and the responsibility for finding the right solution will fall on the corporate secretary most often. There is only one right answer in this predicament: a powerful entity management system that can be customized and optimized to cater to the precise needs of the business in question. If you are interested in working with an entity management software company with over four decades of experience with over 2,000 current clients and an incredible wealth of knowledge, consider Blueprint OneWorld. A dedicated team of service professionals will help install, maintain and update your system as necessary, greatly reducing the stress and costs of the entity management function. If you are interested in setting up a demo, please call us or send us an email.