Whether you’re just starting your first business, or whether you’ve been in the game for decades, it can be easy to forget that there are different ways of structuring your business ownership.
At the most basic level, there are two types of business ownership: sole proprietorship and corporation.
But there are three other types of business ownership that you should consider before making a final decision on which kind of entity to form: partnership, limited liability company (LLC), and S corporation.
Here are the four different types of business ownership and what they entail.
1) Sole Proprietorship
A sole proprietorship is a business owned by one person with no distinction between their personal and business finances.
A sole proprietor doesn’t need to legally register as a business; however, they are responsible for any liabilities incurred in operating that business, meaning it's important to have sufficient assets behind you when starting a business on your own.
According to NerdWallet, Sole proprietorships are not separate legal entities and have unlimited personal liability for all debts.
Sole proprietors are also required to pay self-employment taxes. This means that if you're doing business as an individual using your own name, you'll pay Social Security and Medicare taxes (commonly referred to as payroll taxes) each year.
2) Corporation
A corporation is a legal entity that can act as a separate entity from its owners. Corporations, like other types of business entities, must file articles of incorporation with a state government and pay fees to register their charters.
A corporation generally has two layers between owners and managers—the board of directors and officers.
This means that when you start a corporation, there are more people who must agree on big decisions than in other forms of ownership. A corporation also requires annual reports, tax filings and other financial records.
3) LLC
An LLC, or limited liability company, is a business structure that's increasingly being used. It's a hybrid of S-corporation and partnership taxation and offers flexibility to change your mind down the road.
For example, if you start an LLC and later decide you want it to be taxed as an S-corporation, you can do that by filing a simple form with IRS (known as an election). Keep in mind that having some legal experience is helpful when forming an LLC.
A lawyer can help guide you through questions such as how to draw up contracts with partners and employees; how much capital should be put into reserves; and how much skin each member should have in case your business goes south.
4) S-Corp
An S-Corp is a corporation that elects to be treated as a pass-through entity for tax purposes. As a pass-through entity, an S-Corp doesn’t pay federal income taxes; instead, it distributes any profits to shareholders and passes through any losses.
If you own and operate an S-Corp, you can receive salary or compensation and take a tax deduction on your personal return, but not both. You must also file employment taxes on behalf of your business.
Types of Business Ownership - The Bottom Line
Each type of business ownership comes with its own set of benefits and drawbacks.
No one can decide for you what kind of business ownership is best for you, but as you consider your options it’s important to understand all your choices so that you can make an informed decision about what form is right for your company.
For example, if you’re planning on raising capital from investors in the future, then sole proprietorship or a limited liability company may not be an ideal choice because it limits owners' personal legal liability.
However, if your main objective is to be able to take advantage of key tax benefits that come with being a small business owner then sole proprietorship or a limited liability company might be a great fit after all.
Related Content