How to Choose the Right Business Structure

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The Implications of Your Business Structure Choice

The structure choice you make impacts your business's asset protection, tax classification, and your personal liability. From sole proprietorships and partnerships to LLCs and corporations, this guide aids in understanding these implications and helps you make informed decisions about your business.

How to Choose the Right Business Structure – Transcript

A business structure describes the legal structure of a company, and choosing a business structure is an important step when starting a business. Different business structures come with different tax implications, benefits, and amounts of work needed to keep the business in good legal standing. 

But each business structure has different advantages and disadvantages. So if you're starting a business, which business structure should you choose? In this video, we'll go over the different types of business structures and give you some guidance on choosing the right business structure for your business. 

Remember, this is not professional advice in terms of business, legal, or accounting matters. It's simply a way to help you understand the various business structures and determine which one suits you best. 

After watching this video, if you're still unsure of which business structure is right for your business, we recommend consulting an accountant or lawyer. You can find a list of lawyers who specialize in small business startups using the description or link below. 

Hey everybody, Will Scheren here from Small Business Startup Guide by TRUiC. This video is part of a larger course dedicated to helping small business owners cut through the noise and get to the essentials of starting and operating their business. If that sounds like it would be really useful for you, be sure to like and subscribe. 

Types of business structures – so there's two types of business structures: informal and formal. 

Informal business structures are businesses that operate without any written rules and are not registered as legal business entities with the government. Just about any lemonade stand that you've seen run by a kid on the side of a road would be an example of an informal business. There's two types of informal business structures: sole proprietorships and general partnerships. Sole proprietorships are informal businesses owned by one person, and partnerships are informal businesses owned by two or more people. 

Informal business structures are simple to form, and they're a great way for testing a business in a low-risk environment. They allow you to see if a business will be successful before committing the time and effort needed to form a formal business structure. 

However, informal business structures do not have asset protection. What this means is that if someone sues you or you default on a business loan, your house, car, or personal savings are at risk. Although informal businesses are not registered with the government, informal business owners are still legally required to report any profit that they earn in their informal business to the government on their personal tax return. 

Formal business structures are businesses that operate off of a written set of rules and the registered with the government as a separate legal entity from their owners. There's two types of formal business structures: LLCs and corporations. 

Creating a formal business structure for the business you're creating provides your business with credibility. It legally separates your personal assets from the business, allows you to open a business bank account, and helps build business credit. 

How to choose a business structure for your business – choosing the right business structure for your business is a matter of weighing the value of being able to legally separate your business from your personal assets against the cost of formally registering your business. And if you plan for your business to be successful, there's a good chance that it's well worth the cost of legally separating your business from your personal assets. If, however, you elect for your business to remain as an informal business, no action is needed on your part to form the business. But be sure to let your accountant know how much your business profited when tax time rolls around. 

LLCs are the simplest and most popular business structures for small businesses. In general, it's most beneficial to start a business as an LLC due to its simplicity and the pass-through taxation. It's very easy to start and maintain an LLC. It requires minimal paperwork, and the taxes can be filed when you file your personal income taxes. We’ll hold your hand through starting an LLC in a video later in the course. 

Starting an LLC only takes a few minutes online. TRUiC has negotiated an exclusive deal with Northwest, so our users can register their LLC and get one year of registered agent services for just $29 plus any state fees. 

At TRUiC our mission is to offer all our resources and information for free - but we support our work by using affiliate links, meaning we earn a commission on many of the amazing deals we’ve negotiated for you. Full transparency, Northwest is one such affiliate partner. Link in description below.

Corporations are a more complex business structure and, generally speaking, aren't what you want as a starting business structure unless you're planning to seek venture capital funding or plan to eventually list on the stock exchange. Corporations have more complex requirements in regards to paperwork and rules that you need to follow, and they also have double taxation, which means that your profits are taxed twice. We cover how to start a business as a corporation in a later video in the course as well. 

If you've decided that you need asset protection and that the simplicity and flexibility of a limited liability company suits your needs, that might be all you need to do. You'll have a strong formal business structure in place registered with your state and the federal government, and you'll be free to go on and make a profit. 

Business structure tax classifications – If you elect a formal business structure when forming your business, you'll need to select a tax classification as well. You can choose one of these three tax classifications when forming your LLC pass-through taxation, which is the default, S corp taxation, and C corp taxation. 

Pass-through taxation – the default tax classification for an LLC is pass-through taxation, also known as a disregarded entity for a single-member LLC and partnership for a multi-member LLC. This tax classification avoids double taxation. 

For most small businesses when they start, this is usually the best option when they get started, as they don't know how much profit they'll make, and any profits that they do make are usually reinvested back into the business. In this scenario, the pass-through taxation offers the best flexibility. Also, you can change your tax classification in later years when it makes sense for your business to do so. 

S corp – choosing your LLC to be elected as an S corp is a more complicated process. This S corp tax classification should really only be elected if you know that you'll make a large enough profit and that you intend to take that profit out of the LLC each year rather than reinvesting it back into the business. 

S corp allows you to minimize your tax liability when taking money out of your LLC by allowing LLC members to be employees of the LLC. This enables owners to be paid a reasonable salary which is taxed at a higher rate, and the rest of the profit – hopefully the bulk of the profit – to be paid as a distribution which is taxed at a lower rate. 

The S corp tax classification is really only worth it if you make enough profit to justify the extra cost of being an S corp. Costs include running payroll and higher accounting costs. And be sure to note that the IRS scrutinizes S corps more closely to ensure that owners are paying themselves a reasonable salary and not an artificially low amount. 

Below, we have links that simplify this information and go into further explanation. Use the S corp calculator, which is linked below, to see if an S corp tax designation makes sense for your LLC. 

C corp – LLCs can also elect to be taxed as a C corp. This is only useful if the business plans to carry large amounts of profits between tax years or if you plan to raise venture capital for your company. You should really be speaking to an accountant before you elect this tax classification. This is usually done by more mature businesses. 

We recommend that you spend a few minutes right now getting started and exploring a formal business structure for your business so that your personal assets can be protected from any business liabilities. Check the links below for a list of our most recommended services. 

This video is part of a step-by-step course that gives business owners all of the essential information for starting and operating their business. We provided a link below this video for you to get access to all of the free and discounted business tools that we mention in this course.

Be sure to like and subscribe to get more of this content. We'll see you in the next video, and if you have any questions, let us know.