Business organizations are business structures that are established in the name of conducting business. So, in essence, it is the type of entity that you choose for your company. Depending on what kind of business organization you choose, this will largely determine how you get taxed, among other things associated with the company. The four main types of business organizations are sole proprietorship, limited liability company, partnership, and corporation. Within these, there are varying types of entities that can be created. Of course, there are going to be advantages and disadvantages to each business structure. Keep reading for more about the differences between these business organizations as well as the pros and cons of each.
The 4 Main Types of Business Organizations
Again, depending on how you choose to set up your business, this will affect how you are taxed, how you can raise capital and your ownership structure.
A sole proprietorship is the simplest business structure that exists. It costs virtually nothing to start and as far as taxes go, the process is straightforward. A sole proprietorship is owned by a single individual and everything funnels back to this individual. So for example, on your tax returns, the business’s revenue is listed as personal income. Losses are also listed on personal returns. Among the advantages of establishing a sole proprietorship is the fact that it is so very easy to set up. There is next to no paperwork required. Because you are the sole owner of the company, this means that you retain full control of all business decisions without having to defer to anyone else.
A partnership is set up with two or more owners of the business. These owners generally will share managerial responsibilities as well as financial responsibilities of the company. There are three primary forms of partnerships: general partners, limited and joint ventures. Regardless of the partnership type, the partners usually will share certain aspects related to the business. For instance, they all will generally agree to commit a certain amount of capital/resources to the business. At least one of the partners will be responsible for running the business on a day-to-day basis. And almost always, before establishing your business organization as a partnership, you will want to draft a partners’ agreement stipulating exactly who is responsible for what.
With a general partnership, keep in mind, that all partners are connected to the business; this means, that the partners do not usually have protection from the actions of the company. So if the business accrues a great deal of debt that it cannot pay back, the partners’ assets could be on the line. Taxes will work much as with a sole proprietorship in that the profits and losses will flow through to the partners’ returns, divided accordingly.
With a limited partnership structure, some partners do have the ability to limit their liability. Those who opt to be limited partners are usually referred to as silent partners. While they have a stake in the business and generally invest money, they don’t necessarily have a say in how the company is run. Those who are the general partners in this type of business organization will make the bulk of the management decisions. General partners, keep in mind, are fully liable and thus are not protected from the company’s debts and financial obligations. The limited partners also are not responsible for paying self-employment tax as they receive dividends from the company based upon what they invested.
A corporation represents a legal entity that is run by a board of directors. The board consequently is selected by the shareholders who are considered to be the owners of the company. Unlike a sole proprietorship, a corporation because of its structure can live way beyond the life of the founder.
With a corporation structure, there are a couple of options available. With a C Corp, the company can offer as much stock as it wants and thus have as many owners as it wants. That said, a C Corp will have to pay double the taxes. This means that the owners are taxed via their returns on the dividends they receive, and the corporation itself is also taxed. This double taxation is one of the disadvantages of a C Corp structure.
On the other hand, an S Corp is taxed just once. This is considered a pass-through tax entity where the business income is passed on to the owners. With both an S and C Corp the owners of the company are protected as far as liability goes.
Limited Liability Company
A limited liability company (LLC) has one or more owners (multi-member LLC). Unlike with a sole proprietor though, the owners are protected from the company’s debts and obligations. An LLC is also less expensive to set up than say a corporation and so it has become an increasingly popular business organization type. With this entity, you get the cost-effectiveness and ease of simpler structures but with the protections of a corporation.
Among the other advantages of an LLC, you can have any number of owners that you want. All relevant owners can have a part in operating the business. Taxation is similar to that of a sole proprietorship.
When establishing an LLC, the process will vary from state to state. So you will need to familiarize yourself with the rules of your specific state. You are also going to need to in most cases file articles of organization with the state. You may require an attorney to this end to help you generate the articles. Additionally, when filing these articles, there is usually a fee involved, so definitely find out how much it is going to cost you to create an LLC.