Difference in Business Legal  Structures

Difference in Business Legal Structures

Knowing which legal structure to set up for your business is important. As a new business owner, starting as a sole proprietor is usually the go-to because you don't quite understand the other structures and when to apply them.

 

Sole Proprietorship:

This is the simplest form of business ownership where an individual runs the business and is personally responsible for its debts. The owner has complete control and receives all profits but also assumes unlimited liability for any business obligations.

Setting up as a sole proprietor to obtain things such as a business bank account, business license, and Employer Identification Number (EIN) is permitted. Essentially, you are creating what is known as a DBA (Doing Business As), but the business remains directly connected to you.

 

Partnership:

A partnership is a business structure where two or more individuals share ownership and responsibility for the business. Each partner contributes to the business and shares in the profits and losses. Partnerships can be general partnerships (where partners share equal responsibility and liability) or limited partnerships (where there are both general and limited partners with different levels of liability).

The partnership structure is very important when you are doing business with various people. This is important to ensure that all owners of the business are accounted for and legally held liable for all aspects of the business.

 

Limited Liability Company (LLC):

An LLC combines elements of partnerships and corporations. It provides limited liability protection to its owners (called members) while allowing them to enjoy pass-through taxation, meaning the profits and losses of the business pass through to the members' personal tax returns. LLCs offer flexibility in management structure and are relatively easy to set up.

LLCs are great for many reasons and have very flexible setups. The LLC acts as many things, but most importantly, it acts as a protector for the business and owner. For instance, in the event that your business is sued, the person suing you will only have the right to go after the business assets and not your personal assets. The LLC can be a tool that prevents owners from direct liability for certain business mishaps.

(See S-Corp / C-Corp Detailed Below)

 

Corporation:

A corporation is a legal entity that is separate from its owners (shareholders). It provides limited liability protection to shareholders, meaning their personal assets are generally not at risk. Corporations have a formal management structure with shareholders, directors, and officers. They have more complex legal and tax requirements compared to other structures.

Let's say you plan to raise millions of dollars in funding and bring on a batch of investors. Being a corporation is key in this instance because your business will require a more complex structure. With multiple management levels, shareholders, and board members, this legal structure will be important.

Note: You can still raise funding under other legal structures-- the manner in which you are raising is important. a LLC C-Corp also provides levels of protection to shareholders.

 

Nonprofit Organization:

Nonprofits are formed to pursue charitable, educational, religious, or other socially beneficial purposes. They operate similarly to corporations but have different tax treatment and are exempt from paying certain taxes if they meet specific criteria. Nonprofits are typically governed by a board of directors and must reinvest any surplus revenue back into their mission.

 

Difference in S-Corp and C-Corp

In an S-corporation, the profits and losses "pass through" the business and are reported on the owners' personal tax returns. This means that the corporation itself is not taxed separately. Instead, the owners, also known as shareholders, report their share of the corporation's income and pay taxes on it.

The main benefit of an S-corporation is that it allows the owners to avoid double taxation. Double taxation occurs when the corporation's profits are taxed at the corporate level, and then the owners are taxed again on their personal income when they receive dividends or salary from the corporation. In an S-corporation, this double taxation is generally avoided.

In a C-corporation, the business is considered a separate legal entity from its owners, who are known as shareholders. The corporation files its own tax return and pays taxes on its profits. If the corporation distributes dividends to the shareholders, the shareholders are then taxed on those dividends on their personal tax returns. This means that C-corporations are subject to double taxation.

C-corporations have some advantages, such as the ability to have an unlimited number of shareholders and to easily raise capital by selling shares of stock. They also offer strong liability protection for shareholders, as the corporation's debts and liabilities are generally separate from the personal assets of the shareholders.

To setup your business under these legal structures, you'll need to contact or visit your Secretary of State Office. The process, price and requirements will vary by state.

As for being a sole proprietor, you will not need to contact your Secretary of State. You are able to obtain your EIN and simply get a business license if needed. You are also able to use your personal SSN on business bank account and business license applications.

To obtain a free EIN, you can visit the IRS website here: https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online

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