A business structure is an essential step in starting a new business. The chosen structure can significantly impact various aspects of operation, such as taxation and personal liability. Learning about the most common business structures will assist you in making the best choice for your new business. Knowing the business structure is very important as well as strategies and planning to create a successful business.
In this article, we explain a business structure, look at different types of business structures and their advantages, and talk about what to think about when choosing the best structure for your business.
What is a business structure?
A business structure is the legal setup of a company. It determines things like who owns the business and profit distribution. It’s essential to establish the structure before registering with local, state, or federal governments, as choosing It later can be costly and restrictive to make changes later.
- Day-to-day operations
- Taxes owed
- Amount of required paperwork
- Risk of personal liability
- Ability to raise capital funds
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Some Common business structures
Sole proprietorship
In a sole proprietorship, one person owns and manages the entire business. This is one of the most common business structures because it is the simplest to set up. If you plan to run the business on your own. However, Keep in mind that as the owner, you are sole proprietorship, you, as the owner, for all the business’s financial obligations, including any debt and losses.
A sole proprietorship often works well for low-risk, home-based or retail businesses. Some of the Advantages of this structure include:
1.Complete control
As the sole owner, you have full authority over your business decisions and don’t need to consult with any partners, directors or shareholders.
2.Easier Startup
Settings up a sole proprietorship doesn’t need filing forms or paying government fees, which can help simplify the process and help keep startup costs low.
3.Simple Tax Reporting
Since the business isn’t legally a separate entity, its expenses and income are included on your personal income tax. An added benefit is that you can use business losses to offset your other income, which can lead to a higher tax return.
4.Privacy
Sole proprietorships don’t have to file annual reports with state or federal governments. This means the business doesn’t have to share as much information as it might be in other structures.
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Partnership
In a business partnership, two or more people share ownership and management of the business. It is one of the simplest structures for multiple owners. There are two types of partnerships, all partners have equal roles in owning and running the business. In a general partnership, partners have equal roles in owning and running the business and they share responsibility for its debts or financial obligations. Some people also refer to this business structure as a limited liability partnership (LLP).
A limited partnership (LP) has both general and limited partners. general partners handle the day-to-day roles operation and full liabilities, similar to a general partnership. The limited partners, who are usually investors, have less control or input into the company and limited or no liability.
In a partnership, the partner’s personal tax returns also reflect the business’ profits. Advantages of a partnership structure include:
1.Simple Startup
Starting a partnership doesn’t need paperwork with the federal government, but you may have to file at the state level.
2.Few Tax Forms
In a partnership, the business itself doesn’t pay tax on its income, Instead , the profits and losses pass through to the individual partners personal income tax returns.so you don’t need to file separate business tax returns.
With a co-owner you can split the costs of starting the because such as purchases and overhead costs. Additionally, Banks may also be more willing to offer loans to businesses with multiple owners, which can help with the initial stages of financing the business.
4.Combined Knowledge
A partner can help your business grow by offering skills or expertise in areas where you are leaking. They can also have a different perspective on important operation decisions.
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Corporation
A corporation is its own separate entity, which makes it more complex and expensive to establish. A corporation has to follow more regulations, record-keeping and tax requirements.This structure may be suitable if you’ve already established a medium- or high-risk business, need to raise funds, plan to go public or intend to sell the company. There are various types of corporations. Advantages of corporations include:
1.No double taxation
In an S corporation , Business profits and losses pass directly to the shareholders’ personal incomes and appear on their tax returns. This means the S corporation only pays one level of federal tax and shareholders aren’t taxed at the corporate tax rates.
2.Liability Protection
Shareholders in S corporations are not personally responsible for the business’s debts. This means their personal assets, like bank accounts or property,are protected from creditors.
3.Simple Ownership Transfers
Simple ownership transfers: In an S corporation, shareholders can sell their shares without facing tax consequences. Additionally, the business can keep running smoothly even if a shareholder leaves, just like other corporations.
4.Cash Method of Accounting
Corporations usually use the accrual method for accounting, but S corporations without inventory can use the simpler cash method. With cash accounting, you record income when you get it and expenses when you pay them.
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Limited Liability Company
A limited liability company (LLC) combines features of both partnership and corporation. To set up an LLC, you need to file paperwork with the secretary of state of the state where you’ll operate. This structure is ideal for medium- or high-risk businesses, those wanting to protect your personal assets or pay a lower tax rate compared to a corporation. Advantages of the LLC business structure include:
1.Limited liability
Since an LLC is it’s own legal independent entity, owners are not personally responsible for the company debts or lawsuits. This means personal assets are protected if the business goes bankrupt, though any money invested in the business may be lost.
2.Pass-through Taxation
Instead of paying corporate taxes, an LLC’s income and expenses pass through the owners’ personal tax returns, and they pay tax on the profits. As self employed individuals, the owners can claim the self-employed tax credit, but must handle their own Medicare and Social Security.
An LLC can have an unlimited number of shareholders who all take part in running the business. This business structure offers more flexible management compared to a corporation, which has a board of directors to set policies and officers who handle daily operations.
4.Flexible distribution of profits
An LLC can decide how to share its profits among shareholders. For instance, a shareholder who invested a lot at the start can get a bigger share of the profits, even if their shares are equal to that of another shareholder.
