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4 Different Types of Business Structure [Pros and Cons]

Business structure simply refers to the legal structure of an organization that is acknowledged in a given jurisdiction.

Note that the type of business structure you choose will more or less affect how your business is regulated, taxed, and more. Choosing a legal structure for your business is one of the first decisions you have to make when you want to start a new enterprise.

You have the choice of setting up shop as a sole proprietorship (if you plan to own the business by yourself), a Limited Liability Company, a partnership (if you desire to link up with others), or a corporation.

Each business structure has its advantages and disadvantages, and some also have substructures. Knowing the most common differences can help you select the best legal structure for your personal business circumstance. While choosing a business structure, you must know that there is no right or wrong choice that fits everyone.

Your job is to understand the pros and cons of each legal structure and pick the one that best meets your needs. Another thing that can help you make a well informed choice is to look at the business you want to set up and determine what you want to achieve with it.

Listed below are other things you have to take into consideration before you can pinpoint a legal structure that is perfect for you.

Types of Business Structure

1. Sole Proprietorship

The majority of all small businesses start out as Sole Proprietorship. These firms are owned by one person, usually the individual who has the day-to-day responsibility of running the business. Sole proprietors own all the assets of the business and the profits generated by it.

They also assume complete responsibility for any of its liabilities or debts. In the view of the law and the public, you are one and the same thing with your business.

Currently used by more than 75 percent of all businesses, it is often the suggested way for a new business that does not carry great personal liability threats. The owner simply needs to secure the necessary licenses, tax identification numbers, and certifications in his or her name, and you are free to set up your business.

Major advantages that differentiate the sole proprietorship from the other legal forms are (1) the ease with which it can be started, (2) the owner’s freedom to make decisions, and (3) the distribution of profits (owner takes all).


  • Easiest and least expensive form of ownership to organize.
  • Sole proprietors are in complete control, and within the parameters of the law, may make decisions as they see fit.
  • Sole proprietors receive all income generated by the business to keep or reinvest.
  • Profits from the business flow-through directly to the owner’s personal tax return.
  • The business is easy to dissolve, if desired.


  • Sole proprietors have unlimited liability and are legally responsible for all debts against the business. Their business and personal assets are at risk.
  • They may have problems in raising funds and are often limited to using funds from personal savings or consumer loans.
  • May have a hard time attracting high-caliber employees, or those that are motivated by the opportunity to own a part of the business.
  • Some employee benefits such as owner’s medical insurance premiums are not directly deductible from business income (only partially deductible as an adjustment to income).
  • Sale/Transfer of All or Part of the Business. The sole proprietor can transfer the business only by the sale of business assets. This means it is more difficult to have someone buy into the business, and there are potential tax consequences of converting a sole proprietorship to a corporation or a Limited Liability Company rather than starting out with a durable form of business entity.

A corporation pays 15% federal income tax on taxable income up to $50,000; 25% tax on income from $50,001 – $75,000; 34% tax on income from $75,001 – $100,000; 39% tax on income from $100,001 – $335,000; and 34% tax on income over $335,000.

A sole proprietor who filed a federal income tax return under the status of married, filing jointly, would pay 15% federal income tax on taxable income up to $35,800; 28% tax on income from $35,801 to 86,500; and 31% tax on income over $86,501.

Federal Tax Forms for Sole Proprietorship

  • Form 1040: Individual Income Tax Return
  • Schedule C: Profit or Loss from Business (or Schedule C-EZ)
  • Schedule SE: Self-Employment Tax
  • Form 1040-ES: Estimated Tax for Individuals
  • Form 4562: Depreciation and Amortization
  • Form 8829: Expenses for Business Use of your Home

2. Limited Liability Company (LLC)

The LLC is a relatively new type of hybrid business structure that is now permissible in most states. It is designed to provide the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. Formation is more complex and formal than that of a general partnership.

LLCs provide liability protection. Your personal assets are protected against creditors. LLCs offer pass-through taxation and may avoid the dreaded double taxation. Again, the LLC harnesses the advantages of both corporation and the sole proprietorship while leaving behind their disadvantages.

LLCs were adopted by state law and all 50 states nearly 30 years ago to entice more small business growth. LLCs are the most popular and the most flexible business structure for entrepreneurs, business owners and real estate investors.


  • Owners have limited personal liability for business debts even if they participate in management
  • Profit and loss can be allocated differently than ownership interests
  • IRS rules now allow Limited Liability Corporation (LLC) to choose between being taxed as partnership or corporation


  • More expensive to create than partnership or sole proprietorship
  • State laws for creating Limited Liability Corporation (LLC) may not reflect latest federal tax changes

3. Corporation

A Corporation is also a legal entity (business structure) and it is most often used to run a large company with shareholders and investors (they are not ideal for owning real estate). A corporation, chartered by the state in which it is headquartered, is considered by law to be a unique entity, separate and apart from those who own it.

A corporation can be taxed; it can be sued; it can enter into contractual agreements. The owners of a corporation are its shareholders.

The shareholders elect a board of directors to oversee the major policies and decisions. The corporation has a life of its own and does not dissolve when ownership changes. Compared to sole proprietorships and partnerships, corporations protect their owners from liability.


  • Shareholders have limited liability for the corporation’s debts or judgments against the corporations.
  • Generally, shareholders can only be held accountable for their investment in the stock of the company. (Note however, that officers can be held personally liable for their actions, such as the failure to withhold and pay employment taxes.)
  • Corporations can raise additional funds through the sale of stock.
  • A corporation may deduct the cost of benefits it provides to officers and employees.
  • Can elect S Corporation status if certain requirements are met. This election enables company to be taxed similar to a partnership.
  • A corporation pays 15% federal income tax on taxable income up to $50,000; 25% tax on income from $50,001 – $75,000; 34% tax on income from $75,001 – $100,000; 39% tax on income from $100,001 – $335,000; and 34% tax on income over $335,000.

A sole proprietor who filed a federal income tax return under the status of married, filing jointly, would pay 15% federal income tax on taxable income up to $35,800; 28% tax on income from $35,801 to 86,500; and 31% tax on income over $86,501.

Cons of a Corporation

  • The process of incorporation requires more time and money than other forms of organization.
  • Corporations are monitored by federal, state and some local agencies, and as a result may have more paperwork to comply with regulations.
  • Incorporating may result in higher overall taxes. Dividends paid to shareholders are not deductible form business income, thus this income can be taxed twice.

C Corporation

Federal Tax Forms for Regular or “C” Corporations

  • Form 1120 or 1120-A: Corporation Income Tax Return
  • Form 1120-W Estimated Tax for Corporation
  • Form 8109-B Deposit Coupon
  • Form 4625 Depreciation

S Corporation

A tax election only; this entity enables the shareholder to treat the earnings and profits as distributions, and have them pass thru directly to their personal tax return. The catch here is that the shareholder, if working for the company, and if there is a profit, must pay herself wages, and it must meet standards of “reasonable compensation”.

This can vary by geographical region as well as occupation, but the basic rule is to pay yourself what you would have to pay someone to do your job, as long as there is enough profit. If you do not do this, the IRS can reclassify all of the earnings and profit as wages, and you will be liable for all of the payroll taxes on the total amount.


  • Owners have limited personal liability for business debts
  • Owners report their share of corporate profit or loss on their personal tax returns
  • Owners can use corporate loss to offset income from other sources


  • More expensive to create than partnership or sole proprietorship
  • More paperwork than for a limited liability company, which offers similar advantages
  • Income must be allocated to owners according to their ownership interests
  • Fringe benefits limited for owners who own more than 2% of shares.

Federal Tax Forms for S Corporations

  • Form 1120S: Income Tax Return for S Corporation
  • 1120S K-1: Shareholder’s Share of Income, Credit, Deductions
  • Form 4625 Depreciation
  • Form 1040: Individual Income Tax Return
  • Schedule E: Supplemental Income and Loss
  • Schedule SE: Self-Employment Tax
  • Form 1040-ES: Estimated Tax for Individuals
  • Professional Corporation


  • Owners have no personal liability for malpractice of other owners
  • Disadvantages
  • More expensive to create than partnership or sole proprietorship
  • Paperwork can seem burdensome to some owners
  • All owners must belong to the same profession

Nonprofit Corporation


  • Corporation doesn’t pay income taxes
  • Contributions to charitable corporation are tax deductible
  • Fringe benefits can be deducted as business expense


  • Full tax advantages available only to groups organized for charitable, scientific, educational, literary, or religious purposes
  • Property transferred to corporation stays there; if corporation ends, property must go to another nonprofit

4. Partnership – and the Types

As the name implies, a partnership is when 2 or more people come together and agree to run a business together. Partnerships are essentially a middle ground between a sole proprietorship and corporation. Like sole proprietorships, the laws do not distinguish between the business and its owners.

The partners should have a legal agreement that sets forth how decisions will be made, profits will be shared, disputes will be resolved, how future partners will be admitted to the partnership, how partners can be bought out, or what steps will be taken to dissolve the partnership when needed.

It is difficult to think about a “break-up” when the business is just getting started, but many partnerships split up at crisis times and unless there is a defined process, there will be problems. They also must decide up front how much time and capital each will contribute.

In most countries (depending on state/ province) you’ll need to create a basic partnership agreement, but a handshake can be enough to formalize the partnership. You should have an attorney help you draft the agreement, which usually costs less than $2,000.

Advantages of a Partnership

  • Partnerships are relatively easy to establish; however time should be invested in developing the partnership agreement.
  • With more than one owner, the ability to raise funds may be increased.
  • The profits from the business flow directly through to the partners’ personal tax returns.
  • Prospective employees may be attracted to the business if given the incentive to become a partner.
  • The business usually will benefit from partners who have complementary skills.

Disadvantages of a Partnership

  • Partners are jointly and individually liable for the actions of the other partners.
  • Profits must be shared with others.
  • Since decisions are shared, disagreements can occur.
  • Some employee benefits are not deductible from business income on tax returns.
  • The partnership may have a limited life; it may end upon the withdrawal or death of a partner.

General Partnership

This is the most basic partnership. You do need to get business licenses, but you do not need to file your business with the government.

It’s cheaper and faster to get going, but you both share liability. Partners divide responsibility for management and liability, as well as the shares of profit or loss according to their internal agreement. Equal shares are assumed unless there is a written agreement that states differently.


  • Simple and inexpensive to create and operate
  • Owners (partners) report their share of profit or loss on their personal tax returns


  • Owners (partners) personally liable for business debts

Limited Partnership

Limited Partnership and Partnership with limited liability. “Limited” means that most of the partners have limited liability (to the extent of their investment) as well as limited input regarding management decisions, which generally encourages investors for short term projects, or for investing in capital assets. This form of ownership is not often used for operating retail or service businesses.


  • Limited partners have limited personal liability for business debts as long as they don’t participate in management
  • General partners can raise cash without involving outside investors in management of business


  • General partners are personally liable for business debts
  • More expensive to create than general partnership
  • Suitable mainly for companies that invest in real estate

Federal Tax Forms for Partnerships

  • Form 1065: Partnership Return of Income
  • Form 1065 K-1: Partner’s Share of Income, Credit, Deductions
  • Form 4562: Depreciation
  • Form 1040: Individual Income Tax Return
  • Schedule E: Supplemental Income and Loss
  • Schedule SE: Self-Employment Tax
  • Form 1040-ES: Estimated Tax for Individuals

Which is the Best Legal Structure for your Business?

As has been said, a Sole Proprietorship offers you the business owner no legal protection whatsoever. A Sole Proprietorship is typically setup when someone is unaware of the options they have when it comes to setting up their business structure. In essence, this structure is not protecting anything. Not you, and not your assets.

Corporations on the other hand is not a “bad” business entity… but it is not for everyone. They are best suited for companies that want to go public via an IPO, an initial public offering on the stock market (think Google or Microsoft).

Corporations are best suited for companies that need to raise large amounts of money. Corporations are also required to hold annual meetings, record all meeting notes, and issue shares to the stockholders. Since most entrepreneurs just want to get their business off the ground, a Corporation is usually not the best bet as it will be too complex and costly to maintain.

The disadvantage of a Corporation is what’s called “double taxation”. The Corporation must pay taxes at the federal level, and then the owners must pay taxes again on their dividends (on their personal income tax returns). Corporations are also tedious and expensive to setup.

Again, you’ll need to create a board of directors, corporate officers, and you’ll need to issue stock to the shareholders. Partnership business structure involves more than one person, and because there are more people involved, this entity type has its own issues.

Each owner or member is exposed to unlimited liability for their activities within the business, transferability can be difficult to achieve, and a partnership is unstable as it can automatically dissolve when just one partner no longer wants to participate in the business or can no longer do so. Furthermore, in most of the partnership models, the partners will have unlimited personal liability for the company’s debts.

An LLC on its part is a “hybrid” between a Corporation and a Sole Proprietorship. It harnesses the advantages of both while leaving behind their disadvantages. 

LLCs provide liability protection (your personal assets are protected against creditors) and LLCs offer pass-through taxation (avoid the dreaded double taxation). LLCs were adopted by state law in all 50 states nearly 30 years ago to entice more small business growth.

Till date, LLCs are the most popular and the most flexible business structure for business owners, entrepreneurs and real estate investors. This is because of the advantages that come with this business entity, and in most cases, this entity is suitable for most business operations.

But a note of warning must be sounded here, that an LLC is quite popular does not meant that it is the right legal structure for your business. You have to look at other derivatives before you make your decision, so your business does not suffer it in the long run.

6 Factors to Consider Before Choosing a Legal Structure

For new businesses that decide that they fit perfectly into two or more legal categories, it’s not always easy to decide which one to choose. You need to consider your startup’s financial needs, risk and ability to grow before you can make a choice.

It can be difficult to switch your legal structure after you’ve registered your business, so choosing correctly at the start is very crucial. Before settling with a legal structure, you need to consider the following;

a. Flexibility

To start, you need to ask yourself where your company is headed, and if your structure allows for it. Turn to your business plan to align your goals with the proper structure. Your entity should support the possibility for growth and change, not hold it back from its potential. Note that some structures can limit your business growth.

b. Complexity

When it comes to startup and operational complexity, there is nothing simpler than a sole proprietorship. You simply register your name, start doing business, report the profits and pay taxes on it as personal income.

However, it can be difficult to procure outside funding. Partnerships, on the other hand require a signed agreement to define roles and percentages of profits. Corporations and LLCs have various reporting requirements with the state and federal governments.

c. Liability

Sole proprietors are personally responsible for everything that happens with the business, including any debts incurred through business activity. A creditor of the business can sue the owner and satisfy a business judgment against the owner’s personal assets.

Furthermore, a sole proprietorship is typically operated under the Social Security number of the owner for tax purposes, so business credit transactions show up on the owner’s personal credit report. Comparatively, a corporation and an LLC are independent entities that provide limited liability for owners.

Business creditors typically only can sue the business, and judgments can only be recovered against business assets. Each of these business structures operates under an assigned employer identification number, instead of the owner’s Social Security number.

d. Taxes

An owner of an LLC pays taxes just as a sole proprietor does: All profit is considered personal income and taxed accordingly at the end of the year. A sole proprietor reports business income and expenses on his personal income tax return.

A single-member LLC can choose to be taxed as a sole proprietorship or a corporation. A multiple-member LLC can choose to be taxed as a partnership or a corporation.

A corporation is a taxpaying entity that files an annual tax return and pays taxes on net income at the corporate tax rate, unless the corporation qualifies to make a special tax election to avoid entity-level taxation. Reporting business income as a sole proprietor or partnership is typically much easier than preparing a corporate tax return. Taxes are one of the most important things that inform the choice of a legal structure.

e. Control

If it is important for you to have sole or primary control of the business and its activities, a sole proprietorship or an LLC might be the best choice for you. You can negotiate such control in a partnership agreement as well. A corporation is constructed to have a board of directors that makes the major decisions to guide the company.

A single person can control a corporation, especially at its inception, but as it grows, so does the need to operate it as a board-directed entity. Even for a small corporation, the rules intended for larger organizations – such as keeping notes of every major decision that affects the company – still apply.

f. Capital investment

If you need to obtain outside funding sources, like investor or venture capital and bank loans, you may be better off establishing a corporation, which has an easier time obtaining outside funding than does a sole proprietorship.

Corporations can sell shares of stock, securing additional funding for growth, while sole proprietors can only obtain funds through their personal accounts, using their personal credit or taking on partners. An LLC can face similar struggles, although, as its own entity, it is not always necessary for the owner to use their personal credit or assets.

g. Licenses, permits and regulations

In addition to legally registering your business entity, you may need specific licenses and permits to operate. Depending on the type of business and its activities, it may need to be licensed at the local, state and federal levels. States have different requirements for different business structures. Depending on where you set up, there could be different requirements at the municipal level as well.