Choosing the Right Business Structure: What You Need to Know

Discover the Pros, Cons, and Tax Implications of Different Business Structures to Build a Strong Foundation for Success

Jan 02, 2025

Are you looking to start a business in the New Year? Or do you have an existing business and have questions on choosing the right business structure?

There is a lot to unpack in this space and each business is different but let’s start with the basics.

The structure you select will impact your taxes, liability, ability to raise capital, and even how to operate day-to-day.

Here’s an overview of the most common options and key considerations:

Sole Proprietorship

Overview: Simplest structure, owned by one person.
Pros: Easy to set up, no need to register with the state, and simple tax filing as all of the business information is included on your Schedule C.
Cons: The owner is personally liable for all debts and liabilities. It’s also not ideal for raising capital.

Partnership

Overview: Shared ownership by two or more people.
Taxation: Not taxed at the entity level. Instead, profits and losses are passed through to the partners’ individual returns via Schedule K-1.
Pros: Relatively simple setup and shared responsibilities.
Cons: Partners are personally liable for business debts.

Limited Liability Company (LLC)

Overview: Offers liability protection and flexible taxation.
Taxation: Typically treated as a pass-through entity but you have options/flexibility with this. Members receive a Schedule K-1 and pay taxes at their individual rate.
Pros: Protects personal assets and offers flexibility in management.
Cons: Costs can be higher than sole prop (i.e., a $500 filing fee in Massachusetts). But, worth the investment to get the liability protection in my opinion…

S-Corporation (S-Corp)

Overview: A pass-through entity with stricter rules.
Taxation: Owners must take a reasonable salary subject to payroll taxes, but distributions beyond the salary aren’t subject to self-employment taxes (great way to take money out of your business..)
Pros: Tax advantages for owner distributions (not subject to self employment taxes)
Cons: Limited to 100 shareholders and more regulatory requirements.

C-Corporation (C-Corp)

Overview: A separate legal entity subject to corporate taxes.
Taxation: Profits are taxed at the corporate level (Form 1120), and dividends are taxed again at the shareholder level ("double taxation" => not my favorite for small businesses…)
Pros: Best for attracting investors and retaining profits for growth.
Cons: More complex setup and higher compliance costs.

Liability Protection: Protecting your personal assets is critical. Structures like LLCs and corporations shield you from personal liability, unlike sole proprietorships and partnerships. You don’t set up an LLC to save money in taxes. You do it to cover your ass…
Taxes: Most small business owners prefer pass-through taxation, where profits are taxed at the individual level (i.e. on my own personal tax return). However, C-Corps may offer advantages if you’re reinvesting profits.
Ease of Setup: Sole proprietorships are straightforward, while LLCs and corporations involve more paperwork and fees. But keep in mind, filing an LLC registration is very easy and low cost.
Flexibility: Remember, you can change your structure as your business evolves.

Best Practices For Any Business Owner:

Separate Business and Personal Finances: Open dedicated bank accounts and use credit cards exclusively for business expenses. Separating business and personal expenses can help you avoid tax and legal complications.
Keep Detailed Records: Accurate bookkeeping is essential to track expenses, prepare taxes, and ensure compliance. Hiring a CPA or bookkeeper can save you time and stress. Remember, it’s ‘good till audited’ but prepare for the worst.
Plan for Taxes: If you are a W-2 employee, your taxes are relatively straightforward. Each paycheck, my company withholds Federal and State income taxes for me. I pay Social Security (6.2%) and Medicare (1.45%) taxes, totaling 7.65% of my income and then my employer matches these amounts, contributing the other 7.65%. But as a business owner, I’m responsible for the full 15.3% (12.4% Social Security + 2.9% Medicare) on my net earnings. However, in most situations I get to deduct the “employer” portion (7.65%) of the self-employment tax when calculating my taxable income.
Most business owners also pay quarterly estimated tax payments throughout the year (remember, most owners are not having taxes withheld from each transaction). In order to avoid underpayment penalties, you will need to pay at least 90% of the tax on your current-year return or 100% of the tax shown on the prior year's return.
Leverage Tax Deductions: Take advantage of deductions like business expenses, retirement contributions, and even wages paid to family members.

How can I leverage my business to build more wealth?

You can set up retirement plans for any of the above entity structures. See more here.

You can also help your family. For example, I’m a sole prop and hire my 15 year old son. I pay him just below the standard deduction amount so there is no need to file a federal tax return and then my child has earned income which allows them to contribute to a Roth IRA. I also get to deduct the wages I paid to my child.

This is where you typically want to speak with an expert to help you plan and generate ideas to help your business secure your financial future.

Don’t Let Perfection Delay Progress

While choosing the right structure is important, don’t let it stop you from starting. Many people hide behind the excuse of not knowing the right structure, so they don’t take action. Get started and let the other pieces fall into place.

If you are looking for tailored advice and to ensure you’re on the right track, please reach out.

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