Which Business Type Is Best for Your Company? Choosing a company type is one of the most important choices to make when establishing a business. You’ll receive a lot of advice but think about taxes, control, expense, and responsibility concerns as you sift through it.
This article will break down the characteristics of each main company form, as well as the benefits and drawbacks of each, to assist you in making the best choice for your new venture.
Which Business Type Is Best for Your Company?
Consider the following factors while deciding on a business type.
Which Business Type Is Best for Your Company? Contemplate these four key aspects in your decision-making process when you start your company or consider altering the kind of business you have:
- Costs and complexities of operating a company, such as legal expenses and operational costs
- The tradeoff between control and profits/losses in the context of ownership control
- Taxes on businesses and how they are paid by the company or owner
- Owners’ responsibility for the company’s debts, other owners’ conduct, and general liability
- Organizational Types at a Basic Level
- Because taxes are such a big factor in choosing which company to start, here’s a rundown of the two most common business models.
A corporation is a distinct legal entity from its shareholders, who purchase stock in the company. Taxable dividends are paid to these shareholders by the company. Some owners are also executives or workers, and in addition to collecting shareholder dividends, they are compensated as employees for the tasks they do.
Businesses that pass through
Because the business’s tax obligation is passed through to the owner as a part of the owner’s personal tax return, pass-through companies are known as such. For example, if a single proprietor has a net income of $25,000 on their Schedule C for the year, that amount is added to all other income of the person (and their spouse, if applicable), as well as any business and personal tax credits, to determine the individual’s total tax obligation for the year.
Pass-through entities include sole proprietorships, partnerships, LLCs, and S corporations (a particular kind of company).
States’ Business Models
Corporations, partnerships, and limited liability companies (LLCs) must register with the state in which they want to operate. State business divisions or corporations’ offices establish the requirements and regulations for business formations. Corporations, partnerships, and limited liability companies (LLCs) are legal in all 50 states, but certain variants on these fundamental business structures are not.
For additional information on the registration procedure, contact your secretary of state’s office, which is typically the business division.
Sole proprietorships are a kind of business where the owner is the only person who owns the business (Sole Props)
A sole proprietorship is a business that is run by a single person. The company is not treated as a distinct legal entity from its owner, and it is not required to register with the state. The advantages and disadvantages of this feature are listed below.
On the plus side, a single proprietor has complete decision-making authority and is not subject to the oversight of a board of directors or other shareholders. It also implies that the company’s earnings are distributed entirely to the owner. The taxes are straightforward, consisting of a Schedule C form that is attached to the owner’s personal tax return.
On the negative side, this implies that the company owner is responsible for all losses. It also implies that the owner may be held personally responsible for the company’s debts, in the event of bankruptcy, for litigation brought against the company, and for general responsibility.
Sole proprietorships may be a suitable option for launching a new company in a low-risk environment before establishing a more formal entity.
Businesses (C Corps)
For operations, taxes, and liability reasons, an incorporated company is distinct from its owners. Under the laws of the state in which it operates, the company is established with articles of incorporation. Corporations are expensive to establish because they must have a board of directors, maintain regular meeting minutes and other corporate documents, and report to shareholders, in addition to the state registration.
The company pays its own taxes, but the shareholders pay taxes on dividends, which may result in double taxation in certain instances.
The low corporate tax rates and ease of obtaining money from investors are two advantages of forming a corporation.
PCs and PSCs (Professional Service Corporations) are two types of professional corporations (PSCs)
Professionals in practice with other professionals may form two different kinds of companies.
A professional corporation is a kind of company designed specifically for licensed professionals such as lawyers, physicians, architects, and accountants. In certain states, these experts may establish a company, which provides liability protection. However, each expert is still responsible for their own unlawful professional acts in this kind of company. 2
In contrast, a personal service company (PSC) may only provide personal services. The PSC must satisfy specific IRS criteria, including the number of shares of stock held and the number of services provided by owner-employees, in order to qualify for this status. PSCs may work in a variety of areas.
Corporations with Limited Liability (LLCs)
A limited liability company (LLC) may be formed in any state by filing articles of incorporation or a similar document with the state and drafting an operating agreement to govern member decisions, such as how profits and losses are shared. Members of an LLC are referred to as members, while a single-member LLC is referred to as such.
LLCs are less complicated to set up than corporations, but they provide comparable liability protection.
A partnership is a firm in which two or more people share the company’s risks and rewards, as well as profits and losses. Starting and managing a partnership is very simple. They’ll need to register with a state and form a partnership. They must maintain certain records, but not as many as a corporation.
There are two kinds of partners who may form a partnership:
General partners are those that help run the company day to day and are responsible for the partnership’s debts and activities.
Limited partners are simply investors who have no involvement in the business’s day-to-day operations or liabilities.
Partnerships disclose their tax obligation to the IRS by filing an information return. Because the partners are pass-through entities, no tax is paid on this form. Instead, the profit or loss is split amongst the partners in accordance with their contract. After then, each partner gets a Schedule K-1 form, which shows their portion for the year and is reported on their individual tax returns.