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What Are the Common Forms of Business in the U.S.?
Among the most common forms of business are (1) sole proprietorship; (2) limited partnership (LP); (3) limited liability partnership (LLP); (4) limited liability company (LLC); (5) C corporation; (6) S corporation; (7) benefit corporation; (8) close corporation; (9) nonprofit corporation; and (10) cooperative.
Why Do Business Structures Matter?
Your business structure has a significant impact upon the administrative requirements for your business, your tax liability, your ability to raise funds, and your personal liability. It also has a significant impact upon how your business is controlled.
For these reasons, it probably is a good idea to take some time to understand and consider different business structures available to you before registering your business. Of course, you may convert to a different business structure in the future; however, there may be certain restrictions. Additionally, a conversion could give rise to tax consequences and unintended complications.
What Is a Sole Proprietorship?
A sole proprietorship is easy to form and gives you complete control of your business. Should you engage in business activities without registering your business as any other type, you will automatically be considered to be a sole proprietor.
Sole proprietorships do not produce a separate business entity. This means your business assets and liabilities are not separate from your personal assets and liabilities. You can be held personally liable for the debts and obligations of your business. However, sole proprietors may obtain a separate trade name. Sole proprietors typically face restrictions in raising funds because they cannot sell stock, and lenders are often hesitant to provide funds to sole proprietorships.
Sole proprietorships can be a good choice for low-risk businesses and owners who want to test their business idea before forming a more formal business.
What Is a Partnership?
Partnerships may be considered by two or more people interested in owning a business together. Two common types of partnerships are (1) limited partnerships (LP) and (2) limited liability partnerships (LLP).
Limited partnerships have only one general partner with unlimited liability, and all other partners have limited liability. The partners with limited liability tend to have limited control over the company, which is documented in a partnership agreement. Profits are passed through to personal tax returns, and the general partner, who has unlimited liability, must pay self-employment taxes.
Limited liability partnerships are similar to limited partnerships, but give limited liability to every owner. An LLP protects each partner from debts against the partnership, and they will not be responsible for the actions of other partners.
Partnerships can be a good choice for businesses with multiple owners, professional groups (like attorneys or accountants), and groups who want to test their business idea before forming a more formal business.
What Is a Limited Liability Company (LLC)?
LLCs may allow you to take advantage of the benefits of both the corporation and partnership business structures. Because LLCs can protect you from personal liability in most instances, your personal assets may avoid significant risks when your LLC faces bankruptcy or lawsuits.
Profits and losses can get passed through to your personal income without facing corporate taxes. However, members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security.
LLCs can have a limited life in many states. When a member joins or leaves an LLC, some states may require the LLC to be dissolved and re-formed with new membership, unless there already exists an agreement in place within the LLC for buying, selling, and transferring ownership.
LLCs may be a good choice for medium- or higher-risk businesses, owners with significant personal assets, and owners who want to pay a lower tax rate than they would with a corporation.
What Is a Corporation?
A corporation, sometimes called a C corp, is a legal entity that is separate from its owners. Corporations can make a profit, be taxed, and can be held legally liable on their own.
Corporations offer the strongest protection to their owners from personal liability, but the cost to form a corporation is generally higher than other structures. Corporations also require more extensive record-keeping, operational processes, and reporting.
Unlike sole proprietors, partnerships, and LLCs, corporations pay income tax on their profits. In some cases, corporate profits are taxed twice: first, when the company makes a profit, and again, when dividends are paid to shareholders on their personal tax returns.
Corporations have a completely independent life separate from their shareholders. If a shareholder leaves the company or sells his or her shares, the C corp may continue doing business without being undisturbed. Corporations can raise funds through the sale of stock.
Corporations can be a good choice for medium- or higher-risk businesses, those that need to raise funds, and businesses that plan to go public, or eventually be sold.
An S corporation, sometimes called an S corp, is a special type of corporation designed to avoid the double taxation drawback of regular C corps. S corps allow profits, and some losses, to be passed through directly to owners’ personal income without ever being subject to corporate tax rates.
Not all states tax S corps equally, but most recognize them the same way the federal government does and tax the shareholders accordingly. Some states tax S corps on profits above a specified limit and other states do not recognize the S corp election at all, simply treating the business as a C corp. S corps must file with the IRS to get S corp status, a different process from registering with their state.
To be eligible for S corp status, certain requirements must be met. For example, an S corp must (1) be a domestic corporation; (2) have only allowable shareholders (may not be partnerships, corporations, or non-resident alien shareholders); (3) have no more than 100 shareholders; and (4) have only one class of stock. Additionally, certain corporations (i.e., certain financial institutions, insurance companies, and domestic international sales corporations) are not eligible for S corp status.
S corps are still subject to the filing and operational processes required for C corps.
S corps also have an independent life, just like C corps. Even if a shareholder leaves the company or sells his or her shares, the S corp may continue doing business without being undisturbed.
S corps can be a good choice for a business that would otherwise be a C corp, but can satisfy the eligibility requirements for S corp status.
A benefit corporation is a for-profit corporation recognized by a majority of U.S. states. Benefit corporations are different from C corps in purpose, accountability, and transparency, but are not different in how they are taxed.
Benefit corporations are driven by both mission and profit. Shareholders hold the company accountable to produce some sort of public benefit, in addition to a financial profit. Some states require benefit corporations to submit annual benefit reports that demonstrate their contribution to the public good.
There are several third-party benefit corporation certification services, but none are required for a company to be legally considered one in a state where the legal status is available.
Close corporations have a less traditional corporate structure. These shed many formalities that typically govern corporations and apply to smaller companies.
State rules vary, but shares are usually barred from public trading. Close corporations can be run by a small group of shareholders without a board of directors.
Nonprofit corporations are organized to do charity, education, religious, literary, or scientific work. Because their work benefits the public, nonprofits can receive tax-exempt status, meaning they need not pay state or federal income taxes on any profits it makes.
Nonprofits must file with the IRS to get tax exemption.
Nonprofit corporations need to follow organizational rules very similar to a regular C corp. They also need to follow special rules about what they do with any profits they earn. For example, they cannot distribute profits to members or political campaigns.
What Is a Cooperative?
A cooperative is a business or organization owned by and operated for the benefit of those using its services. Profits and earnings generated by the cooperative are distributed among the members, also known as user-owners.
Typically, an elected board of directors and officers run the cooperative while regular members have voting power to control the direction of the cooperative. Members can become part of the cooperative by purchasing shares, although the amount of shares they hold does not affect the weight of their vote.
Can Different Business Structures Be Combined?
Such designations as S corp and nonprofit may not necessarily be business structures in the strictest sense. They could also be understood as a particular tax status.
For example, it is possible for an LLC to be taxed as a C corp, S corp, or a nonprofit. These arrangements may require an additional process to set up.
As explained above, your business structure is an important factor determining the administrative requirements for your business, your tax liability, your ability to raise funds, and your personal liability. It also has a significant impact upon how your business is controlled.
Accordingly, before creating and registering your business, you should consider the particular traits of each of the business structures available to you. You should also be mindful of such ownership rules, liability matters, taxes, and filing requirements for each business structure as are governed by the state statutes in your jurisdiction.
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