When starting a small business, there are a lot of legal details, reports, and forms to work through to remain compliant. A very crucial part of this first step is choosing the right business structure for your specific company. You should choose a business structure that gives you the right balance of legal protections and benefits. In Ohio, some of the main legal business structures are sole proprietorship, general partnership, limited partnership, limited liability company, C-corporation, S-corporation, and nonprofit corporation. Below is a general breakdown of these different types of business structures:
Sole Proprietorship: A sole proprietorship consists of an individual who owns a business by himself or herself. Regarding flexibility, a sole proprietorship is easier to form, usually cheaper, and gives the owner complete control of the business, however, it does not produce a separate business entity. More specifically this means that 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 the business. Also, raising capital is often more difficult in a sole proprietorship, because banks are often hesitant to lend to a sole proprietorship and sole proprietorships cannot sell stocks.
Limited Liability Company: A limited liability company operates similarly to S and C corporations (both discussed below) regarding liabilities. Having the Limited Liability Company limits the amount of personal liability and debts of its members in regard to the action of the LLC.
Partnership: Partnerships are the simplest structure for two or more individuals joined together in a business or venture. Each partner contributes to the business and is expected to share all profits and losses that the business may incur. There are two common types of partnerships: limited partnerships and limited liability partnerships. Having the LLC designation limits the amount of personal liability and debts of its members regarding the actions of the LLC.
Limited Partnerships: Limited partnerships have only one general partner with unlimited liability, and all other partners have limited liability. The partners with limited liability usually have limited control over the company, which is documented in the partnership agreement. Profits are passed through to personal tax returns, and the general partner, the partner without limited liability, must also pay self-employment taxes.
Limited Liability Partnerships: A limited liability partnership is like limited partnerships but gives limited liability to every owner. It protects each partner from debts against the partnership, so they won’t be responsible for the actions of other partners. A limited liability company protects you from personal liability in most situations, such as your personal assets including your house, which won’t be at risk in case the company faces lawsuits or bankruptcy. Each member is considered self-employed and must pay self-employment tax contributions, but profits and losses are treated as personal income without facing the corporate taxes.
C-Corporation: A C corporation (C-Corp) is a legal entity that is separate from its owners. It can make a profit, be taxed, and can be held legally liable. They offer the strongest protection to its owners from personal liability, but the cost to form a corporation is higher than other structures. Corporate profits can be taxed twice both when the company brings in a profit and personally when dividends are paid out to the shareholders. A plus side for having a C-Corp is when it comes to raising capital because they can raise funds through the sale of stock. If a shareholder leaves the company or sells his or her shares, the business is unaffected.
S-Corporation: This type of corporation is viewed differently than a C corporation in regard to profits and losses. Some profits and losses to be passed through directly to an owner’s personal income without ever being subject to corporate tax rates. An S corporation does not pay taxes on profits when earned by the corporation, but rather pass the profit or loss onto the shareholders to be claimed on their individual income tax returns. However, there are limitations in S-Corps; S-Corps cannot have more than 100 shareholders and all shareholders must be U.S. citizens. Just like C-Corps, S-Corps have an independent life, and if a shareholder leaves the company or sells his or her shares the company can continue relatively undisturbed.
Nonprofit Corporation: Organized to aid in charity, education, religious, literacy, or scientific work, nonprofit corporations benefit the public. Often called 501(C)(3) corporations, this type of business structure is granted as tax-exempt status which means they do not pay state or federal income taxes on any profits it makes.
In summary, choose carefully; Your business structure affects how much you pay in taxes, your ability to raise money, the paperwork you need to file, and your personal liability. The Law Office of Charles H. McClenaghan can provide support and guidance to ensure your business is set up correctly! Contact us at (614) 429-1053 to set up a consultation!