Choosing a Business Structure
According to the U.S. Census Bureau, there were over five million new business applications submitted in 2022 alone. All individuals pursuing the dream of exercising their entrepreneurial muscles will face the same question, “Which business structure should I adopt?”1
Each strategy presents its own set of pros and cons. To complicate matters a bit, the 2017 Tax Cuts and Jobs Act created several key changes that may benefit certain business structures. For example, the new law added a 20 percent deduction of qualified business income for certain pass-through entities. However, service industries (e.g., health, law, professional services) are generally excluded, except where income is below $364,200 for joint filers and $182,100 for other filers. This provision is set to expire on December 31, 2025.2
This overview is not intended as tax or legal advice and may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding the most appropriate business structure for your organization.
This structure is the simplest. But it creates no separation from its owner. Income from the business is simply added to the individual’s personal tax return.3
Advantages: Easy to set up and simple to maintain.
Disadvantages: Owners are personally liable for the business’s financial obligations, thus, exposing their personal assets (house, savings, etc.). It does not offer the prestige or sense of permanence of a corporation or LLC.
A C-corporation is a separate legal entity from its owners, making it easier to raise money, issue stock, and transfer ownership. Its life is perpetual and will survive the owner’s death.3
Advantages: There may be tax advantages, including more allowable business expenses. It protects owners from personal liability for the company’s financial obligations and may lend a measure of prestige and permanence.
Disadvantages: More expensive to set up, the paperwork and formality are greater than for a sole proprietorship or LLC. Income may be taxed twice, once at the corporate level and once when distributed to owners as dividend income.
After forming a corporation, an owner may elect an “S-Corporation Status” by adopting a resolution to that effect and submitting Form 2553 to the IRS.3
The S-corporation is taxed like a sole proprietorship, i.e., the company’s income will pass through to shareholders and be reported on their respective personal tax returns.
Advantages: S-corporations avoid the double taxation issue associated with C-corporations, while enjoying many of the same tax advantages. Owners are shielded from personal liability for the company’s financial obligations. It provides the prestige of a corporation for small businesses.
Disadvantages: S-corporations do not have all the tax-deductible expenses of a C-corporation. The cost of set up, the paperwork, and formality are greater than for a sole proprietorship or LLC. S-corporations have certain restrictions, including a "100 or fewer" shareholders requirement. Shareholders must be U.S. citizens, and the business cannot be owned by another business.
Limited Liability Company
An LLC is a hybrid between a corporation and a sole proprietorship, offering easy management, pass-through taxation, and the liability protection of a corporation. Similar to a corporation, it is a separate legal entity, but there is no stock.3
Advantages: LLCs provide the protections of a corporation but are taxed similar to a sole proprietorship.
Disadvantages: Typically more expensive to form than a sole proprietorship, LLCs require more paperwork and formalized behavior.
Remember, the choice of business structure is not an irreversible decision. You may amend your business structure to accommodate your changing needs and circumstances.
1. Census.gov, 2023
2. Investopedia.com, February 24, 2023
3. IRS.gov, 2023