Choosing the right legal structure is a necessary part of running a business. Whether you’re just starting out or your business is growing, it’s crucial to understand the options. Before you can register your company, you need to decide what kind of an entity your business will be. This legal decision affects everything from how you file your taxes to your personal liability. The most common business entity types are sole proprietorships, partnerships, limited liability companies, corporations, and cooperatives. Here’s more about each type of legal structure.

Types Of Legal Business Structures

  • Sole proprietorship: A sole proprietorship is basically an unincorporated business owned and run by one individual (no partners are involved), with no distinction between the business and its owner. As a sole proprietor, you are entitled to all profits and are responsible for all your business’s debts, losses, and liabilities. A sole proprietorship is the easiest business structure to form (you only need to get a license or permit and register your business with your local government.) It is also a simple structure to maintain with few forms and little business administration needed. Many freelancers, consultants, and independent contractors operate as sole proprietors for ease and convenience. Be warned that this route can directly affect your personal credit.
  • Partnership: An association between two or more people in business seeking a profit. Partnerships can be created with little formality, but because more than one person is involved, a partnership agreement should be created. A partnership agreement stipulates the terms of the partnership by formalizing rules for profit/loss sharing, ownership percentages, dissolution terms, and management rights among many other things. Similar to sole proprietorships, partnerships retain full, shared liability among the owners. Partners are not only liable for their own actions, but also for the business debts and decisions made by other partners. In addition, the personal assets of all partners can be used to satisfy the partnership’s debt.
  • Corporation: Corporations are the most complex business structure. A corporation is a legal entity that is separate and independent from the people who own or run the corporation, namely shareholders. A corporation has the ability to enter into contracts separate from that of the shareholders, but it also has certain responsibilities such as the payment of taxes. Corporations are generally more appropriate for larger established companies with multiple employees. Ownership is designated by issuing shares of stock. Corporations can own their own property, assume liability, pay taxes, enter contracts, sue and be sued like any individual. There are S and C corporations. The big difference between the two is that C corporation shareholders are subject to double taxation. Most smaller firms are S corps.
  • LLC (Limited liability company): Finally, there are LLCs. The most important difference between them and S corporations is how the IRS treats excess profits. Or in IRS jargon, “distributions.” This hybrid structure has the legal protection of a corporation while allowing for the tax benefits of a partnership. LLCs require less paperwork than S corporations.

Determining the legal structure for your business is an incredibly important decision. If you feel you need more information before you make a decision it is best to discuss your options with a business advisor.

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