A person sitting at a desk plans to change his business structure

Consider Changing Your Business Structure

When you formed your business, it's likely that you imagined what your business could become and chose a business structure that made sense for that vision. Now that your business is maturing, it’s time to reevaluate your choice and decide whether another structure would better suit your needs.

 

Why does my business structure matter?

Your business structure matters for two important reasons:

  1. It influences the taxes you pay.
  2. It determines whether—or how much of—your personal assets are at stake in the event of default.

 

But beyond taxes and liabilities, your structure plays a part in defining the rules you must follow, including how you’ll need to formalize decisions, how you can raise money, and whether you need to fulfill certain state filing requirements.

What worked for your business on Day 1 may not be the best choice today, so here's what you can do now: Review the following structure options and see if there is a better fit for your business.

 

What are my choices?

There are eight popular business structures:

  1. Sole proprietorship
  2. General partnership
  3. Limited partnership
  4. Limited liability company (LLC)
  5. C corporation (C corp)
  6. S corporation (S corp)
  7. Nonprofit
  8. Cooperative (co-op)

 

What are the key differences?

The following chart provides a high-level overview of the key differences. Be sure to speak with an attorney and a representative from your state’s Secretary of State office or their Department of Taxation to learn how the rules could vary in your state.

Type of structure

Who can own it

Personal liability

Tax obligations

Sole proprietorship
One personUnlimitedPersonal taxes
General partnership
Two or more peopleUnlimitedPersonal taxes

Self-employment taxes, except for limited partners

Limited partnership
Two or more peopleUnlimited for general partners

Minimal for the limited partner

Personal taxes

Self-employment taxes
for the general partners

Limited liability company (LLC)
One or more peopleMinimalPersonal tax

Self-employment tax

C corporation
One or more peopleMinimalCorporate tax
S corporation
One to 100 U.S. citizensMinimalPersonal tax
Nonprofit
One or more peopleMinimalTax-exempt
Cooperative
One or more peopleLimitedCorporate tax

 

Ready to learn more? Let's explore each structure.

 

Sole proprietorship

A sole proprietorship is a business that’s owned and operated by one person. The owner/operator has full control of the business and full discretion over the decisions that are made.

 

How it’s formed:

Sole proprietorships are the default form of organization. Unless you register as another form of business, your state will recognize your business as a sole proprietorship when you file your state’s formation paperwork.

 

Advantages:

  • Sole proprietorships are the easiest structure to establish.
  • As the sole owner, you have full discretion over how you’ll run your business.
  • Sole proprietors can avoid the double taxation that impacts other ownership arrangements by reporting business profits and losses on their personal tax returns.

 

Disadvantages:

  • You will be personally responsible for the business’s taxes, debts, and claims against the business.
  • Creditors can seize your personal assets to reclaim debts.
  • You may struggle to raise the cash you need because banks are often hesitant to lend to sole proprietors.
  • You can’t raise cash by selling stock.

 

General partnership

A general partnership is a co-ownership arrangement between two or more people who share legal and financial responsibility for the business.

 

How it’s formed:

General partnerships are formed with a partnership agreement. This agreement should be drafted by an attorney and signed by every ownership partner.

 

Advantages:

  • Each partner shares in the responsibility of running the business.
  • The partners can pool their strengths, resources, and connections to benefit the business.
  • Partners may be able to attain loans with favorable terms because of the strength of their combined credit ratings.
  • Partnerships avoid the double taxation that impacts other ownership arrangements by reporting business profits and losses on the partners’ personal tax returns.
  • The ability to allocate losses to owner partners can increase the business’s internal rate of return on investment and may afford the partners some income tax benefits.

 

Disadvantages:

  • Each partner is personally responsible for the business’s taxes, debts, and claims against the partnership.
  • Each partner is liable for other partners’ debts.
  • Creditors can seize any partner’s personal assets to reclaim debts.
  • Each partner can commit the business and other owners to obligations without signed consent.

 

Limited partnership

A limited partnership is an arrangement that includes one or more general partners who have full legal and financial responsibility for the business and one or more partners whose liability is limited to the amount they invest in the business.

 

How it’s formed:

Like a general partnership, limited partnerships also require a partnership agreement. This agreement should be drafted by an attorney and signed by every ownership partner.

 

Advantages:

  • As a general partner, you can raise the capital you need for acquisition without giving others a say in its daily operations.
  • You can repay the investments your partners make in the business on terms you both agree to (such as when the business has a certain amount of excess profits) rather than at fixed intervals of time.
  • Partnerships avoid the double taxation that impacts other ownership arrangements by reporting business profits and losses on the partners’ personal tax returns.
  • The ability to allocate losses to owner partners can increase the business’s internal rate of return on investment and may afford the partners some income tax benefits.

 

Disadvantages:

  • You, as the general partner, are responsible for the entirety of managing the business.
  • You bear full responsibility for the business’s debts, taxes, and claims.
  • Creditors can seize your personal assets to reclaim the business’s debts.

 

Limited liability company

A limited liability company (LLC) combines elements of a partnership and a corporation. Like a partnership, the LLC allows owners to avoid paying corporate-level income taxes because the owners report the business’s profits and losses on their personal income tax return. And, like a corporation, the LLC helps protect owners’ personal assets from the business’s debts and liabilities.

 

How it’s formed:

Owners file Articles of Organization with their state and pay a filing fee.

 

Advantages:

  • Unless you use your personal assets as collateral for business loans, creditors cannot seize those assets to reclaim business debts.
  • LLCs avoid the double taxation that impacts other ownership arrangements by reporting business profits and losses on the owners’ personal tax returns.
  • The ability to allocate losses to owner partners can increase the business’s internal rate of return on investment and may afford the owners some income tax benefits.

 

Disadvantages:

  • Your company cannot issue stock.
  • Some small businesses are ineligible to form an LLC. Certain states exclude banking or insurance businesses, accounting firms, architecture firms, and medical practices, among others.

 

C Corporation

A C Corporation (C corp) is a legal structure for businesses with multiple owners. Through this structure, owners’ personal assets are typically shielded from the business’s debts and financial obligations. Businesses that use this structure have an elected board of directors, adopt bylaws, issue stock, hold shareholder meetings, file annual reports, and pay annual fees related to their formation. They are taxed separately from their owners, and the owners also pay tax on the income they receive from the business.

 

How it’s formed:

Owners file Articles of Incorporation with their state and pay a filing fee.

 

Advantages:

  • Unless you use your personal assets as collateral for business loans, creditors cannot seize those assets to reclaim business debts.
  • You can offer multiple classes of stock to suit investor preferences.
  • You may offer shares to as many individuals or entities as you like, and they do not have to reside in the United States.
  • Your company’s shareholders can sell and transfer their shares freely.
  • You may be able to deduct all of your business’s charitable contributions and donations, provided they don’t exceed 10% of your company’s income, as well as some benefits, including health insurance.
  • Recent tax reform policies may allow you to pay a lower corporate tax rate than the maximum rate that’s currently in place for individuals.

 

Disadvantages:

  • Because the business must pay tax on its earnings and the shareholders must pay tax on their dividends, the corporation’s earnings are taxed twice.
  • The rules for corporations are strict and complicated.
  • The costs of running a business as a C corp are higher than in some of the other arrangements.
  • Extensive documentation is needed to establish this type of business.

 

If you plan to issue stock but won’t publicly trade shares, you may consider organizing as a close corporation. In this structure, you and a select group of individuals may own and operate the business without dealing with some cumbersome reporting requirements or outside shareholder pressures. Speak with an attorney to learn more about this structure.

 

If your business is a for-profit entity that serves a social good, you may wish to speak with an attorney about registering as a benefit corporation. There are some benefits (but no tax savings) to registering with this structure.

 

S corporation

An S Corporation (S corp) is a legal structure that shares many similarities with the C corp, but there are two key differences. First, a business organized as an S corp can issue only one class of stock to a limited number of U.S. resident shareholders (presently 100) rather than multiple classes of stock to an unlimited number of shareholders. Second, the S corp itself doesn’t pay tax. Instead, the owners report the business’s revenue as personal revenue.

 

How it’s formed:

Owners file Articles of Incorporation with their state and pay a filing fee, and they file Form 2553 with the IRS.

 

Advantages:

  • Unless you use your personal assets as collateral for business loans, creditors cannot seize those assets to reclaim business debts.
  • You and other shareholders don’t have to pay a corporate-level income tax.
  • Because of the Tax Cuts and Jobs Act (2017), you and other shareholders may be able to deduct up to 20% of your net qualified business income.
  • Your business’s losses will pass through to its shareholders, who may be able to use the losses to offset income.

 

Disadvantages:

  • Because your business is limited to 100 shareholders, you may have difficulty raising large amounts of capital.
  • The shareholders of your business cannot be entities, so you won’t be able to raise capital from venture capitalists or private equity funds.
  • You will likely need to limit your shareholders’ ability to sell or transfer their shares to ensure shares aren’t given to an ineligible shareholder, a move that could terminate your S corp status.
  • Your shareholders will be taxed on the business’s profits, even if income isn’t distributed to them as cash.

 

Close corporation and benefit corporation structure are also available to entities electing S corp status. Speak with an attorney to learn more about these structures.

Nonprofit

Nonprofit corporations are organized to do work that benefits the public. Generally, their work involves charity, education, religion, literature, or science.

 

How it’s formed:

Owners must file articles of incorporation, apply for IRS and state tax exemptions, and follow state-specific procedures for registration.

 

Advantages:

  • Your business isn’t required to pay state or federal income taxes on profits.
  • Your business may not be required to pay real estate taxes or sales taxes.
  • Unless you use your personal assets as collateral for business loans, creditors cannot seize those assets to reclaim business debts.

 

Disadvantages:

  • This business structure isn’t for entities that aim to make a profit.
  • You can’t issue stock to raise capital.
  • It can be more difficult to attain lender financing.

 

Cooperative

A cooperative is an organization that’s owned and operated by the people who use its services. It isn’t a suitable arrangement for most businesses, but it offers advantages to certain groups.

 

How it’s formed:

Owners file Articles of Incorporation with their state, create bylaws, draft a membership application, and elect directors.

 

Advantages:

  • The arrangement prioritizes the collective good of the group rather than an owner.
  • You and other member-owners of the cooperative don’t have to pay a corporate-level income tax.

 

Disadvantages:

  • Decision-making isn’t centralized; rights are shared among the members of the co-op.
  • Profits and earnings are shared among member-owners.

 

How do I change my business structure?

Your attorney can help you formalize the arrangement you choose and walk you through the state-specific steps you’ll need to take to register or re-register your business.

This guide can help you work through the work you'll need to take on:

 

Briefly, the steps you might need to take include completing your state’s registration process, drafting and filing new organizing documents, and obtaining a new federal employer identification number from the IRS. You may also need to reapply for permits or licenses to operate.

If you move from a sole proprietorship or partnership to an LLC or corporation, you may need to open new bank accounts to separate your business and personal assets. You may also need to make changes to your insurance policies and vendor contracts to address the changes you make to your liability status.

Be sure to work with an attorney who can help you cover your bases as you change your business structure. Would you like to connect with an attorney? Click the button below to get started:

 

Want to know more about working with a small business attorney. This guide is a great resource:

 

What’s next?

Making sure your business is positioned for tax, legal, and risk concerns is important, but there are lots of other considerations to keep in mind to help your business perform at its best. Log into your owner’s portal for free, personalized guidance that will help you structure your business for success.

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