How To Decide On Your Business Ownership Structure

Choosing the right ownership structure is one of the most important financial decisions you’ll make when starting a small business. It affects how you file taxes, what you owe, how profits are distributed and whether your personal assets are at risk if the business runs into legal trouble. Your decision could save — or cost — you thousands of dollars in the long run.

According to U.S Census Bureau data, sole proprietorships account for around 86 percent of nonemployer firms and 13 percent of small employer firms, while more than half of small employer firms are structured as S corporations. These are just two of the common business structures you can choose from. Understanding how they differ and the pros and cons of each entity type can help you decide which business structure is the most cost-effective.

Common business structures

Understanding the basics of each business structure type can help you decide which is the best option.

Sole proprietorship

A sole proprietorship is the simplest business structure, where one person owns and operates the business. There’s no legal distinction between the owner and the business, meaning you’re responsible for all debts and legal obligations. The setup is easy to establish and maintain but offers no liability protection.

Consider this structure if you’re a freelancer, have a side hustle, your business is low risk or you want to test out your business idea before creating a formal business entity.

Pros

• Complete control over business decisions and finances
• Simple and inexpensive to start
• Taxes are filed with your personal return using a Schedule C

Cons

• Harder to raise capital
• Self-employment taxes can be high
• Unlimited personal liability

Partnership

A general partnership involves two or more people who share ownership of a business. A limited partnership (LP) includes one partner with unlimited liability, while the rest have limited liability and control of the business. All partners in a limited liability partnership (LLP) have limited liability. The general partner takes the most risk and must pay self-employment taxes. Limited partners are protected from partner debts and profits pass through your personal tax return.

This structure may be a good fit for married couples starting a business and companies with multiple owners, such as restaurant groups and attorney firms.

Pros

• Easy to establish with minimal startup costs
• Pass-through taxes avoids double taxation
• Shared financial commitment

Cons

• All partners are personally liable for business debts (except LLP)
• Potential for financial or strategic disagreements
• Profit sharing can reduce individual earnings

Limited liability company

An LLC blends the simplicity of partnerships with the liability protection of corporations. Owners (called members) are generally not responsible for business debts. An LLC can also protect your personal assets from company lawsuits or bankruptcy. LLCs offer flexible tax options — they can be taxed as sole proprietorships, partnerships or corporations, depending on elections made with the IRS.

If you have significant personal assets to protect, are in a medium- or high-risk industry and want to pay less taxes than a corporation, consider an LLC business structure.

Pros

• Flexible tax treatment
• Limited personal liability
• Unlimited number of members

Cons

• More complex and costly than sole props and partnerships
• Rules vary by state
• Self-employment taxes may apply

C corporation

A C corporation, or C corp, is a legal entity separate from its owners, providing the strongest personal liability protection. It can raise capital by issuing stock, making it ideal for businesses planning to seek investors or go public. However, C corporations can face double taxation — once on corporate profits and again on dividends paid to shareholders.

Pros

• Easier to raise capital
• Limited personal liability
• Unlimited shareholders and growth potential

Cons

• Complex to establish and maintain
• More regulatory requirements and costs
• Possible double taxation of income

S Corporation

An S Corporation, or S corp, is a special tax status available to certain corporations and LLCs that meet IRS requirements. It allows income and some losses to pass through directly to shareholders’ personal tax returns, avoiding double taxation. However, S corps have stricter operational rules and eligibility requirements, like filing with the IRS using Form 2553 to get status in addition to registering with your state.

If you meet the criteria for an S corp, it may be a more cost-effective alternative than filing as a C corp.

Pros

• Avoid double tax with pass-through taxation
• Limited liability protection for shareholders
• Potential self-employment tax savings

Cons

• More IRS regulations and formalities
• No more than 100 shareholders
• Strict IRS eligibility rules

How to decide which business structure makes sense

Consider the following financial and operational factors when deciding which business structure makes the most sense for your company.

Risk tolerance with personal assets

How much personal liability are you willing to accept? Structures like LLCs and corporations protect personal assets, while sole proprietorships and partnerships do not.

Business taxes

Pass-through structures like sole props, partnerships and S corps allow you to report business income on your personal tax return, which can potentially save you money. While C corps pay corporate and dividend taxes, they may offer better tax planning opportunities for growing businesses.

Management style

Sole proprietors have total control, while partnerships and corporations require collaboration and shared decision-making. Choose a structure that fits how you want to lead and operate your business.

Administrative complexity

Sole proprietorships and partnerships are easier and cheaper to maintain. LLCs and corporations require more paperwork, compliance and filing fees.

Long-term goals

Think about your goals for growth, raising capital and selling or transferring your business. Corporations are better suited for raising investments and ownership changes. If you don’t plan to expand or go public, a sole proprietorship may fit your needs.

Bottom line

Your business structure sets the stage for how you handle taxes, liability and finances. While simpler setups like sole proprietorships may work for freelancers or very small businesses, those looking for growth, protection or outside funding may benefit more from an LLC or corporation. The right choice can save you time, money and stress, so take the time to evaluate your options carefully.

Frequently asked questions

• How do you choose which form of ownership would be best for a business?
  

  Consider factors like your risk tolerance, whether you need outside financing for your business and if you want it to continue or be transferable if you can no longer run your business. If you prefer to be in control and don’t want to share profits, a sole proprietorship may be best. However, if you have one or more partners, want to limit personal liability or plan to go public, a corporation or LLC may be better.

• Does a sole proprietor need a business bank account?
  

  Although it’s not a legal requirement, having a business bank account can separate your business and personal assets. It can also help you track expenses and prepare for taxes easier. Some business checking accounts come with other potential perks like free accounting software and invoicing capabilities.