Entrepreneurs face many critical decisions as they launch their businesses. Among the most important is selecting the best business structure for their company. Because of the legal, financial, administrative, and operational implications of the entity chosen, business owners have many factors to consider. For instance, what is the best business structure for their industry and type of business?
In this article, we’ll explore some of the things to keep in mind as you select an entity type for your new business. And I’ll offer some insight into which business structures might offer the most advantages to certain types of businesses. This information may prove helpful as business owners talk with their attorney, accountant, and financial advisor for guidance about the entity type that will best suit their needs and goals.
Important Business Structure Considerations
1. Industry Liability Risks
The type of work a business conducts impacts the potential for legal issues. Liability risks come in many forms and vary depending on business activities, whether the company has employees, the regulatory environment, and other factors.
Examples of commercial liability risks include slip and fall accidents, employment-related risks such as discrimination; sexual harassment, payroll issues, breach of employment contracts; product liability such as losses; property damage, or injury caused by a product made or sold by the business; security breaches such as cyber-attacks that compromise customer’s personal information; and failure to meet government rules and regulations.
Some industries and types of business carry more risks than others. For example, a retail store with a brick-and-mortar location has risks that a wholly online retailer does not. For instance, the store might face a lawsuit if a customer hurts themselves after tripping over a cord or uneven floorboard. An owner of an online storefront doesn’t have that worry.
Examples of industries with high liability risks include construction, agriculture, food and beverage, gaming, health services, manufacturing, fishing, trash collection, hospitality, and the cannabis industry.
Entrepreneurs are wise to consider their liability risks when choosing a business structure. Below, I’ve shared how some business structures stack up regarding personal liability protection for business owners.
- Sole Proprietorships and General Partnerships — These two business entities offer no liability protection for business owners because Sole Proprietorships and Partnerships are considered the same legal entity as their owners. The business owners are personally liable for the business’s legal claims and financial debts. If someone were to sue the business or the company owes a creditor money, the Sole Proprietor or Partners are responsible. Therefore, their personal assets and property could be taken to settle those debts.
- Limited Liability Partnerships — An LLP limits liability. Generally, all partners in a Limited Liability Partnership (LLP) are protected from the legal issues and debts of the partnership beyond their individual investment in the business (hence the term “limited” liability). However, some states hold LLP partners liable for certain types of debts (such as money owed to creditors). This entity type is typically formed by licensed professionals such as accountants, dentists, financial advisory firms, business consultancies, and real estate agencies. Individual partners are still liable for their own negligence or wrongdoing and may be held responsible for the malpractice of the employees they directly supervise.
- Limited Liability Companies — An LLC limits liability. By forming a Limited Liability Company (LLC), business owners (also called members) receive protection for their personal assets. An LLC is a separate legal entity from its owners. Generally, LLC members will not be personally liable for legal issues and debts of the business beyond their personal financial investment in the company. However, if business owners’ negligence or intentional wrongdoing causes harm to someone or results in business debt, a court might rule that the owners ARE responsible. Therefore, their personal property (home, car, retirement savings, etc.) might be seized as damages. Likewise, if business owners have not kept an LLC in good standing with the state, a court may rule that it pierced the corporate veil, thus voiding the protection from personal liability. LLCs taxed as S Corporations (more on that below) have the same limited liability protection as a regular LLC. Also, there are variations of the LLC, such as a Professional Limited Liability Company (PLLC) or Series LLC (SLLC), that might be advantageous to certain types of businesses.
- C Corporations — A C Corporation limits liability and has more compliance checks and balances. Incorporating a business as a C Corporation creates an independent entity separate from its owners ( also called shareholders). Corporate shareholders’ liability is limited to their financial investment in the company. The business owners’ personal assets are typically protected from the corporation’s financial debts and lawsuits. A C Corp’s employees, directors, and officers also have liability protection. However, failure to follow compliance rules or individuals’ own negligence or wrongdoing can result in losing personal liability protection. C Corporations have checks and balances in place (e.g., a board of directors and officers) to oversee that the company is being operated in accordance with its governing document (bylaws). That can help reduce the potential for non-compliance and improper activity. C Corporations taxed as an S Corporation have the same limited liability protection as a regular C Corporation. Also, there are variations of the corporation, such as a Professional Corporation (PC) or Nonprofit Corporation, that might be advantageous to certain types of businesses.
2. Income Taxes
The business structure an entrepreneur chooses also affects how the company and its owners are taxed. Here’s an overview of how the IRS treats the most popular entity types from a tax perspective.
- Sole Proprietorship and Partnerships – These business structures are considered the same legal and tax-paying entity as their owners. A one-person (or married couple) or multi-person business not registered with the state as a formal business entity is considered to be operating as a Sole Proprietorship or Partnership. Sole proprietorships and partnerships are “pass-through” entities for income tax purposes. Business profits and losses pass through to the owners’ personal tax returns. All taxable income is subject to self-employment taxes (Medicare and Social Security) — that’s because the owner doesn’t receive a paycheck from which those taxes are deducted. Usually, Sole Proprietors and partners must make quarterly estimated tax payments to the IRS, state, and local tax authorities throughout the year.
- Limited Liability Partnerships – The IRS does not consider an LLP a separate income tax-paying entity from its owners. The business’s profits and losses are allocated among the company’s partners, according to each partner’s share of ownership or another percentage as established in the LLP’s partnership agreement. LLP partners report their portion of the company’s earnings on their individual income tax returns and pay their tax due through their personal tax accounts. Although the LLP entity does not pay income tax, the IRS does require LLPs to file an information return to report income, gains, losses, deductions, credits, etc.
- Limited Liability Companies – By default, the IRS does not consider the LLC to be its own tax-paying entity, so it’s taxed as a pass-through entity. The IRS requires that business profits and losses flow through to the LLC members’ personal tax returns. All of the business’s taxable income is subject to self-employment taxes (Social Security and Medicare) and income tax — regardless of whether the business owners personally use that money or leave it in the business. Usually, LLC members must make quarterly estimated tax payments to the IRS, state, and local tax authorities throughout the year.
- C Corporations – With the standard tax treatment for C Corporations, the business’s profits and losses flow through to the C Corporation’s corporate tax return and are taxed at the corporate federal income tax rate. Corporations that pay dividends to their shareholders experience “double taxation.” Income paid as dividends is not tax-deductible for the business. So, the C Corp pays income tax on those profits at the corporate level, and then the individual shareholders report and pay tax on that money again on their personal tax returns.
- S Corporations – An S Corporation isn’t a business structure in and of itself but rather a tax election option that eligible LLCs and C Corporations may choose. When an LLC is taxed as an S Corporation, only the income paid to the LLC’s members through payroll is subject to Social Security and Medicare taxes (called FICA). Profits paid as distributions to LLC owners are not subject to FICA taxes. This may help business owners lower their personal tax burden because they don’t have to pay Social Security and Medicare taxes on ALL of their income. When a C Corporation is taxed as an S Corporation, the corporation’s profits and losses flow through to shareholders’ personal tax returns. The business does not pay corporate income tax, avoiding the double taxation of some income that occurs with standard C Corp tax treatment.
3. Growth Opportunities
Another thing entrepreneurs should think about is whether they intend to grow or expand their business. As companies add to their workforce, offer more products and services, and acquire new customers, liability risks may also increase. And some business structures are set up more effectively for raising capital than others to fuel growth. For example, financial institutions and investors may require that a business is operating as an officially registered entity before they will provide loans or other funding.
Tip: Not all business structures allow for an unlimited number of owners. For instance, a sole proprietorship may have only one owner (an individual or a married couple), and an LLC or C Corp taxed as an S Corporation may have no more than 100 members or shareholders.
4. Control Over the Company
Some entrepreneurs like to have complete control over every aspect of their business. Sole Proprietorships and General Partnerships put the business owners in the driver’s seat (Remember, though, that full control also means full personal liability!). LLC members may have complete control while enjoying the protections of limited liability — or they may have one or more managers they appoint or hire to handle some of the day-in and day-out business decisions. In a C Corporation, strategic direction and major decisions often come through the board of directors rather than the business owners.
5. Succession
Another consideration is whether business owners want their company to continue its existence after they no longer are a part of it. Sole Proprietorships end when the owner dies or stops doing business, they cannot be sold or transferred to another party. Partnerships, LLCs, and corporations have unlimited duration. Provided they follow the rules of the state and their governing documents (i.e., partnership agreement, LLC operating agreement, or bylaws), they can continue to operate perpetually after owners leave, die, or are involuntarily removed from the company.
Best Business Structures for Different Industries and Types of Businesses
By now, you’ve probably realized a lot goes into determining which business structure to choose. So, there’s no 100% foolproof way to say, “This business entity type is right for that type of business.” Only by taking the specific circumstances, needs, and goals into consideration — and discussing them with legal and financial advisors — can business owners determine the most advantageous business entity type.
I can, however, offer food for thought by providing examples of what industries and types of businesses might benefit from specific business structures. Realize that every business’s situation and needs are different. Also, in addition to the types of business structures I’ve included in my chart, states may have other options available, too. And some of the entities I’ve mentioned may not be available in every state.
Accounting and Law Firms
Considerations, Concerns, and Risks: Contractual obligations, employee matters, building code regulations and government oversight, heavy machinery investments, the potential for injuries and property damage on job sites, and seasonal income fluctuations.
Business Structures: LLC, S Corporation, C Corporation
Reason: Owners may benefit from the personal liability protection and tax flexibility these structures provide. Also, these structures may make it easier for business owners to get bank loans, get funding from investors, or add additional partners to finance growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
Childcare
Considerations, Concerns, and Risks: Contractual obligations, strict state and local government regulatory oversight, physical contact with children, employee matters.
Business Structures: LLC, S Corporation, C Corporation
Reason: Owners may benefit from the personal liability protection and tax flexibility these structures provide. Also, these structures may make it easier for business owners to get bank loans, get funding from investors, or add additional partners to finance growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
Cleaning
Considerations, Concerns, and Risks: Contractual obligations, employee matters, injury risks, theft and property damage risks.
Business Structures: LLC, S Corporation, C Corporation
Reason: Owners may benefit from the personal liability protection and tax flexibility these structures provide. Also, these structures may make it easier for business owners to get bank loans, get funding from investors, or add additional partners to finance growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
Construction
Considerations, Concerns, and Risks: Contractual obligations, employee matters, building code regulations and government oversight, heavy machinery investments, the potential for injuries and property damage on job sites, and seasonal income fluctuations.
Business Structures: LLC, S Corporation, C Corporation
Reason: Owners may benefit from the personal liability protection and tax flexibility these structures provide. Also, these structures may make it easier for business owners to get bank loans, get funding from investors, or add additional partners to finance growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
Consulting
Considerations, Concerns, and Risks: Contractual obligations, sensitive customer data, potentially inconsistent income, and employee matters.
Business Structures: LLC, S Corporation, C Corporation
Reason: Owners may benefit from the personal liability protection and tax flexibility these structures provide. Also, these structures may make it easier for business owners to get bank loans, get funding from investors, or add additional partners to finance growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
E-Commerce (Online Stores)
Considerations, Concerns, and Risks: Contractual obligations, customer payment information, employee matters, and intellectual property rights.
Business Structures: LLC, S Corporation, C Corporation
Reason: Owners may benefit from the personal liability protection and tax flexibility these structures provide. Also, these structures may make it easier for business owners to get bank loans, get funding from investors, or add additional partners to finance growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
Farming
Considerations, Concerns, and Risks: Employee matters, crop contamination risks, weather-related crop damage risks, heavy machinery investment, injury and accident risks, and contractual obligations.
Business Structures: LLC, S Corporation, C Corporation
Reason: Owners may benefit from the personal liability protection and tax flexibility these structures provide. Also, these structures may make it easier for business owners to get bank loans, get funding from investors, or add additional partners to finance growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
Food and Beverage
Considerations, Concerns, and Risks: Employee matters, contractual obligations, the potential for injuries (staff and guests), risk of food-borne illnesses, thin profit margins, and possibly seasonal income fluctuations.
Business Structures: LLC, S Corporation, C Corporation
Reason: Owners may benefit from the personal liability protection and tax flexibility these structures provide. Also, these structures may make it easier for business owners to get bank loans, get funding from investors, or add additional partners to finance growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
Freelance Creative Professionals
Considerations, Concerns, and Risks: Contractual obligations, copyright law, inconsistent income, and typically home-based businesses with no employees.
Business Structures: LLC, S Corporation
Reason: This structure has minimal formation paperwork and ongoing compliance requirements. For single-person business owners, the simplicity and tax flexibility of the LLC are attractive features.
Healthcare
Considerations, Concerns, and Risks: Malpractice claims, strict government oversight, confidential health records, physical contact with patients, and employee matters.
Business Structures: LLP, PLLC, PC
Reason: These entity types limit personal liability for licensed professionals, like physicians, dentists, veterinarians, etc. LLPs and PLLCs have fewer formation and ongoing compliance requirements than PCs, while PCs may be more attractive to investors if the business owners wish to obtain funding for growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
Hospitality
Considerations, Concerns, and Risks: Employee matters, contractual obligations, the potential for injuries (staff and guests), risk of food-borne illnesses, thin profit margins, and possibly seasonal income fluctuations.
Business Structures: LLC, S Corporation, C Corporation
Reason: Owners may benefit from the personal liability protection and tax flexibility these structures provide. Also, these structures may make it easier for business owners to get bank loans, get funding from investors, or add additional partners to finance growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
Manufacturing
Considerations, Concerns, and Risks: Employee matters, heavy machinery investment, product defects, injury and accident risks, and contractual obligations.
Business Structures: LLC, S Corporation, C Corporation
Reason: Owners may benefit from the personal liability protection and tax flexibility these structures provide. Also, these structures may make it easier for business owners to get bank loans, get funding from investors, or add additional partners to finance growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
Real Estate Investments and Rental Property
Considerations, Concerns, and Risks: Contractual obligations, potentially heightened risk of injuries and property damage, employee and contractor matters.
Business Structures: LLC, Series LLC
Reason: By limiting liability, these structures may help protect investors and the individual properties they own from the liabilities of the other properties. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
Retail Stores (Traditional Brick and Mortar)
Considerations, Concerns, and Risks: Contractual obligations, customer payment information, employee matters, and on-site injury risks.
Business Structures: LLC, S Corporation, C Corporation
Reason: Owners may benefit from the personal liability protection and tax flexibility these structures provide. Also, these structures may make it easier for business owners to get bank loans, get funding from investors, or add additional partners to finance growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
Spas and Salons
Considerations, Concerns, and Risks: Employee matters, physical contact with clientele, product ingredient allergies, and contractual obligations.
Business Structures: LLC, S Corporation, C Corporation
Reason: Owners may benefit from the personal liability protection and tax flexibility these structures provide. Also, these structures may make it easier for business owners to get bank loans, get funding from investors, or add additional partners to finance growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
Trucking Companies
Considerations, Concerns, and Risks: Contractual obligations, employee and contractor matters, injury and accident risks, freight liabilities, and volatile fuel expenses.
Business Structures: LLC, S Corporation, C Corporation
Reason: Owners may benefit from the personal liability protection and tax flexibility these structures provide. Also, these structures may make it easier for business owners to get bank loans, get funding from investors, or add additional partners to finance growth. These legal entity types have perpetual existence if they follow the rules of the state and their governing documents.
The Bottom Line
Entrepreneurs must do their homework and consult with legal and tax experts to ensure they make informed decisions. A business entity affects companies legally, financially, operationally, and administratively. Choosing the best business structure for your business is an important task and it should not be taken lightly! For more information about business entity types and to understand which ones might benefit you, visit CorpNet’s Learning Center.
Ready to start your business — and do it right? CorpNet is here to help you prepare and file your formation and compliance documents. Schedule a free consultation today!
