Welcome to our #AskACPA feature where we answer financial, accounting and business questions.
Question: What business structure is best for my side hustle and/or small business?
Answer: The answer is: “It depends!” There are a number of factors that go into deciding the right structure for your business, including tax, liability, funding and personal considerations. As a small business owner, you must choose a business structure before registering your business with the state. Let’s start by taking a look at some of the most common structures for businesses…
Sole Proprietorships
A sole proprietorship is one of the most straightforward business structures, as it’s easy to form and gives its owner complete control over the business. If you perform business activities yet have not registered as any other kind of business, you’re automatically considered to be a sole proprietorship. You are also able to get a trade name.
However, this also means your business assets and liabilities are not separate from your personal liabilities and assets. In other words, you may be held personally liable for any obligation of the business. In addition, raising money may be challenging as banks may be more reluctant to lend to sole proprietorships, and your structure doesn’t allow you to issue and sell stocks.
Who is this for?
A sole proprietorship may be a good choice for anyone wanting to test the waters for their business idea first, and in general, for any low-risk business.
Partnerships
Are you and one or many partners planning to own a business together? Then a partnership may be the right business structure for you. Keep in mind there are two main types of partnership structures, including Limited Partnerships (LP) and Limited Liability Partnerships (LLP).
In Limited Partnerships, only one general partner has unlimited liability and must pay self-employment taxes, while the other partners have limited liability and limited control over the company. Any profit is passed through to the partners’ personal tax returns, hence the reason why partnerships are also known as “pass-through” entities.
As for Limited Liability partnerships, they afford their owners limited liability, thus protecting them from debts against the partnership.
Who is this for?
Similar to sole proprietorships, partnerships may be good for groups of owners wanting to test their ideas before building a more formal structure. In general, partnerships are well suited to professional groups such as accountants or lawyers.
Limited Liability Company (LLC)
Are you looking to have both the advantages of partnerships and corporations?
Do you have a medium to high-risk business?
In this case, you may elect to form an LLC. While an LLC protects you from personal liability in case the business faces a lawsuit or bankruptcy, it also can allow for profits and losses to pass through to your personal income and avoid corporate taxes. LLC members, however, are treated as self-employed and have to pay the self-employment tax.
Who is this for?
LLCs are well suited to members who own sizable personal assets they need to protect, as well as owners who aspire to a lower tax rate than the corporate tax, and medium or higher risk businesses.
Corporations
There are many corporations, including:
C corporations
C Corporations are legal entities separate from their owners, and protect the latter from legal liability. As a matter of fact, they can be taxed, make a profit, and be liable legally. In many instances, C corporations can be taxed
A great advantage of corporations consists in their ability to raise capital through the sale of stock. However, they are more costly to form than other structures, and demand more complex processes, reporting and record-keeping.
Who is this for?
C corps are a good choice for medium to higher-risk businesses in need of capital.
S Corporations
S Corporations help you avoid the double taxation that C corps are subject to. Profits and losses are passed through to the owners’ income without being taxed at corporate rates. S corporations may be taxed differently depending on the state they’re in.
Who is this for?
S corporations are good options for businesses that would be structured as a C corporation, but do qualify to be an S corporation.
B Corporations
Benefit corporations, called B corporations, are for-profit corporations taxed like C corporations. However, they are required by shareholders to generate a public benefit, in addition to financial profits.
Who is this for?
B corporations are a good choice for business owners interested in producing a public benefit along with financial profits.
Close corporations
Similar to B corporations, close corporations are less traditionally structured. They are usually not traded publicly. Usually, they can be run by small groups of shareholders. However, they don’t have a board of directors.
Who is this for?
Close corporations are well suited for business owners who do not want a traditional corporate structure.
Nonprofit corporation
Nonprofit corporations, often called 501(c)(3), are usually dedicated to dong charity, religious, educational, scientific or literary work to benefit the public. As such, they can receive tax-exempt status allowing them not to pay state or federal income taxes on their profits. However, they follow an organizational structure similar to a C Corporation.
Who is this for?
Nonprofit corporations are a good choice for business owners who want to do work to benefit the public.
Cooperative
Cooperatives are businesses or organizations benefiting those using its services, also known as user-owners. They are run by an elected board of directors and officers. Members can join the cooperative through the purchase of shares, and distributed profits among themselves.
Who is this for?
Cooperatives are for owners interested in using the services and sharing the profits of the business among themselves.
After reading about these different structures, which one(s) do you think appeal most to you?
The Corporate Sis.
