Consider Changing Your Business Structure

Katie Fleming

Katie Fleming

Co-founder and COO of Owner Actions

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

When you formed your business, you may have pictured 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 a change to your business structure would better suit your needs.

 

Why does my business structure matter?

Your business structure matters for two important reasons:

  1. It affects 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 spells out the rules you must follow. These can include how you’ll 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?

Refer to this chart for a high-level overview of the key differences. Keep in mind that rules can vary by state. Speak with an attorney and a person from your state’s Secretary of State office or their Department of Taxation to learn more.

Type of structure

Who can own it

Personal liability

Tax obligations

Sole proprietorship
One person Unlimited Personal taxes
General partnership
Two or more people Unlimited Personal taxes

Self-employment taxes, except for limited partners

Limited partnership
Two or more people Unlimited for general partners

Minimal for the limited partner

Personal taxes

Self-employment taxes
for the general partners

Limited liability company (LLC)
One or more people Minimal Personal tax

Self-employment tax

C corporation
One or more people Minimal Corporate tax
S corporation
One to 100 U.S. citizens Minimal Personal tax
Nonprofit
One or more people Minimal Tax-exempt
Cooperative
One or more people Limited Corporate 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 has full control of the business and full discretion over the decisions that are made.

 

How it’s formed:

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.

 

What's great about this setup:

  • Sole proprietorships are the easiest structure to establish.
  • As the sole owner, you have full say on how you’ll run your business.
  • Sole proprietors can avoid the double taxation that impacts other arrangements. Business profits and losses are reported on your personal tax return.

 

The drawbacks:

  • 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.

 

What's great about this setup:

  • Each partner shares responsibility for 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 arrangements. Business profits and losses are reported on the partners’ personal tax returns.
  • The ability to allocate losses to owner partners can increase the business’s internal rate of return. It may also afford the partners some income tax benefits.

 

The drawbacks:

  • 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 between two or more people or businesses. One or more is a general partner with full legal and financial responsibility for the business. The other(s)' 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.

 

What's great about this setup:

  • As a general partner, you can raise the capital you need without giving others a say in the 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 arrangements. Business profits and losses are reported on the partners’ personal tax returns.
  • The ability to allocate losses to owner partners can increase the business’s internal rate of return. It may also afford the partners some income tax benefits.

 

The drawbacks:

  • You, as the general partner, are fully responsible for 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.

 

What's great about this setup:

  • 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 arrangements. Business profits and losses are reported on the owners’ personal tax returns.
  • The ability to allocate losses to owner partners can increase the business’s internal rate of return. It may also afford the owners some income tax benefits.

 

The drawbacks:

  • Your company cannot issue stock.
  • Some businesses are barred from forming an LLC. In some states, these include 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 one or more 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. 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.

 

What's great about this setup:

  • 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 people or entities as you like, and they do not have to live in the US.
  • 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.

 

The drawbacks:

  • 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 complex.
  • The costs of running a business as a C corp are higher than in some of the other setups.
  • Extensive documentation is needed to set up this type of business.

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If you plan to issue stock but won’t publicly trade shares, you might organize as a close corporation. In this setup, you and a select group of people can own and run the business without dealing with 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, speak with an attorney about registering as a benefit corporation. There are some benefits (but no tax savings) to choosing this structure.

 

S corporation

An S Corporation (S corp) is a legal structure that's much like a 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.

 

What's great about this setup:

  • 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 could use the losses to offset income.

 

The drawbacks:

  • Because your business is limited to 100 shareholders, you may struggle to raise large amounts of capital.
  • The shareholders of your business cannot be entities, so you can't 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.

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Close corporation and benefit corporation structure are also options for 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.

 

What's great about this setup:

  • 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 them to reclaim business debts.

 

The drawbacks:

  • 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 owned and operated by the people who use its services. It isn’t suitable for most businesses. Still, 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.

 

What's great about this setup:

  • 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.

 

The drawbacks:

  • 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?

An attorney can help you formalize the arrangement you choose. This pro will also 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 those steps:

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But briefly, here are some of the tasks you might need to take on as you change your business structure:

  • Complete your state’s registration process
  • Draft and file new organizing documents
  • Obtain a new federal employer identification number from the IRS
  • Reapply for permits or licenses to operate (if needed)

 

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. Still, 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 a free step-by-step guide to structure your business for success.

Want to take on other tasks?

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