If you are starting a new business, deciding the legal structure of that business may be one of the most important decisions you make. The legal structuring of your business will determine important details such as required paperwork, personal liabilities, and how you raise money and taxes. The right decision could lead to many benefits. However, the wrong decision could lead to tax penalties, restructuring or even the dissolution of the company. To help avoid these pitfalls, our Palo Alto business attorney has collected a list of common business structures and brief explanations of how they function.
This is the simplest business structure available. It involves just one individual owning and operating a business. This structure doesn’t set the enterprise up as a separate entity, but it does give the owner full control over every aspect of the business. A sole proprietorship also allows you to apply business expenses and earnings to your personal tax return. So, if your business takes a loss, you may use those losses to offset your taxable income. However, there are some drawbacks to this company structure.
When it comes to liability, your assets and the business’ assets are not separate. That means the business owner can be held liable for the debts and lawsuits filed against their company. For some, this could be a serious risk to their personal livelihood. These drawbacks are why sole proprietorships are better suited to low-risk businesses and owners wanting to test their business ideas.
The next simplest business structure is the partnership. This company structure comes in two forms:
- Limited Partnerships (LP), and
- Limited Liability Partnerships (LLP).
In an LP, one general partner takes on all unlimited liability while the others have limited liability. This means the limited partners are not liable for the decisions made by the general partner. In exchange for this liability protection, the limited partners also have limited control over the company.
In an LLP, every owner is granted limited liability from the actions of the other partners. It also protects the partners from debts incurred against the partnership. These protections make LLP’s a popular option for professionals such as doctors and lawyers. The tax advantages and disadvantages this structure offers can also make consulting a Palo Alto business attorney critical for any partnerships being formed here in California.
As the most complex type of business structure, corporations need a lot of legal assistance as well as large capital investments. These business structures are considered separate legal entities from their owners, so owners are not personally responsible for corporate liabilities. Common types of corporation structures include:
- C Corporations (C corp),
- S Corporations (S corp),
- Benefit Corporations (B corp), and
- Nonprofit Corporations (Nonprofits).
S corps and C corps are similar in the protection they provide shareholders against liability, but there are key restrictions and tax differences between these structures. C corps are subject to double taxation—first from income taxes against corporate profits, and second from taxes on dividends paid to shareholders. S corps can pass on some losses and profits to shareholders without being subject to corporate taxation, but they can only have 100 shareholders.
B corps are subject to special taxation separate from the other corporate structures. However, a B corp must turn a profit while also fulfilling a purpose or mission. To prove that this mission is being fulfilled, B corps must file reports demonstrating a contribution to the public good. Nonprofits must also file reports proving their charitable, educational or religious work. But unlike b corps, nonprofits are exempt from most federal income taxes and some state taxes. Though any profits earned by a nonprofit cannot be distributed to shareholders or political campaigns.
Limited Liability Company (LLC)
Applying principles from both the corporate business structure and partnerships, the LLC protects personal assets from your company’s liabilities. This business structure also takes advantage of pass throughs as an S corp would, but LLC members must pay self-employment tax.
Since LLC’s and Corporations provide strong liability protections, they are often employed by medium to high-risk business ventures. They are also often used by business owners that have significant personal assets that could be endangered by the business’ liabilities.
Our Redwood City Business Counseling Law Firm May Have Answers to Your Questions
Each of these business structures not only has significant tax implications, but when used properly, they can also boost your business. Our Palo Alto business attorney understands these benefits and restrictions. We provide trusted business counseling to companies and individuals all over the Bay Area. At Winghart Law Group, Inc., our clients often recommend our services to their friends and family, so give us a call at (650) 332-2994. We offer a 30-minute free consultation to review the legal issues your business is facing.