The business structure you choose for your consulting practice is an important decision. It influences critical factors relating to your operations, such as personal liability, ownership, and taxes. Read on to learn about common business structures.
Important Note: This resource is for general information purposes only and may not cover important considerations that apply to you and your business. As such, the information provided below does not constitute legal or other professional advice. We recommend consulting with licensed legal and financial professionals in your jurisdiction to address your particular situation.
Sole Proprietorship
A sole proprietorship might be the right fit for an owner that is testing out their business idea before investing more in the business.
A person doing business activities (and hasn’t otherwise registered as a business entity) is automatically considered a sole proprietorship.
This business structure is a one-person business, and it does not result in a separate legal entity. Therefore, your business assets and liabilities are not separate from your personal assets and liabilities. That means your personal assets (house, car and other personal possessions) are fair game when it comes to a lawsuit against your business, bankruptcy or other business debts and claims.
This business structure has its benefits. It’s easy to set up and maintain; you don’t have to keep up with annual filings, and business income is treated as personal income that is reported on your individual income tax return. A legal entity isn’t required to obtain a trade name, so you can apply for and operate your business under a trade name as well.
Be sure to understand and comply with any local registrations, business licenses or permit laws that may apply to your business. In addition, you’ll have to pay self-employment tax.
Partnership
A partnership is created when two or more owners come together and agree to go into business with each other.
There are two kinds of partnerships: general partnerships and limited partnerships. General partnerships are more simple and inexpensive to set up and maintain. The information below focuses on general partnerships only.
A partnership is similar to a sole proprietorship in that:
- A general partnership is relatively simple to form and maintain.
- A partnership isn’t a separate legal entity, and so partners are personally liable for business debts and claims. Additionally, partners typically have joint liability (meaning any individual partner can be liable for the other partners’ actions or failure to act).
- Pass-through entity for tax purposes (business income is treated as personal income that is reported on the owner’s individual income tax return). Owners also need to pay self-employment tax.
- Formal registration is not required, but a partnership still needs to comply with applicable tax and regulatory requirements (e.g., business licenses, state tax registration and employer registration).
- A partnership can apply for and operate under a trade name.
While not legally required, the partnership may establish a partnership agreement to cover items such as each partner’s contribution to the partnership, allocation of profits and losses, and the level of control the partners have.
Corporation
A corporation (sometimes called a “C corp”) is a legal entity that provides its owners limited liability but is more expensive to set up and maintain.
A corporation is separate from the owner(s) of the business. The business owns assets, pays taxes, and takes on obligations separate from its owners. Additionally, the personal assets of the owners are shielded from the corporation’s debts and claims (with certain exceptions).
Corporations offer protection for the owner(s) but are often more costly than other business structures. For instance:
- Corporations owe income tax on profits. Sometimes the profits are double-taxed: (1) corporate tax owed when the profit is made and (2) shareholders taxed at their personal tax rates for the dividends earned from those profits.
- Corporations require more extensive upkeep, such as filings for formation and annual state filings, record-keeping, and formalities (e.g., annual shareholders’ and board meetings, maintaining a separate bank account).
Corporations may be an ideal choice for businesses that plan to raise capital or eventually pursue an exit strategy (IPO or sell).
S Corporation
An S corporation (sometimes called an “S corp”) is a type of corporation that avoids the double-tax that C corps have.
S corps allow business income to be passed through to the owners’ personal income and is therefore not subject to corporate tax. Because of this tax treatment, you must file with the IRS (rather than the state) to get S corp status. Not all states tax S corps the same, and some states do not recognize the S corp business structure altogether.
Like C corps, S corps offer owners limited liability and can be costly due to the state filings, record-keeping and formalities.
LLC
A limited liability company (LLC) is a popular choice for anyone starting a business or is looking to add more credibility to and protection for their sole proprietorship or partnership.
An LLC is a legal entity that provide the protection of a corporation and the pass-through taxation of a sole proprietorship or partnership.
The owner(s) of an LLC (called “member(s)”) have limited liability, meaning the personal assets and liabilities of the owner(s) aren’t at risk when it comes to business debts and claims.
For tax purposes, an LLC is a pass-through entity (business income is treated as personal income that is reported on a member’s individual income tax return). Therefore, there is no corporate tax.
Forming an LLC requires you to file formation documents with the state. However, setting up and maintaining an LLC is less burdensome than a corporation.
Lastly, creating an LLC can give you and your business more credibility for your clients.
|
Business Structure |
Ownership |
Tax |
Are Owners Personally Liable? |
|
Sole Proprietorship |
1 person |
Personal tax Self-employment tax |
Yes |
|
Partnership |
2 or more people |
Personal tax Self-employment tax |
Yes |
|
LLC |
1 or more people |
Personal tax or corporate tax Self-employment tax |
No |
|
C Corporation |
1 or more people |
Personal tax Corporate tax |
No |
|
S Corporation |
1 or more people (must be U.S. citizens) |
Personal tax |
No |
Insurance
Forming a business entity doesn’t take the place of business insurance. Even where the business structure protects your personal assets, insurance provides additional protection for your corporate assets in the event of a lawsuit or claim.
Additionally, business entities that offer you limited liability will have exceptions. For example, an owner of a corporation can be held liable if he, she or they personally and directly injures someone. Getting the proper insurance for your business can cover you for these types of accidents and more.