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Choosing Your Small Business Legal Structure

One important consideration when starting your business is determining the best legal organizational structure. Why? Because it will affect operating efficiency, transferability, control, the way you report income, the taxes you pay and your personal liability.

Four basic structure types are available:

  • Sole proprietorship
  • Partnership — general and limited
  • Corporation — S corporation, C corporation
  • Limited liability company (LLC)

The choices can be complicated — and errors can be costly. Business legal structures are regulated by state governments, but your county or municipality also may have license requirements. What’s more, current tax laws make it difficult to change your legal structure after you begin operating. Making the right decision before you open for business is very important.


  • The simplest legal structure for any business
  • The business is not legally separated from you — the owner. (By default, the legal business name is the same as your legal name)
  • Establishing a business name separate from your own is possible by creating a “doing business as” (DBA) name. Most states require DBAs to be registered with the county clerk or Secretary of State • Owner can take cash withdrawals from the business at will
  • Owner required to make quarterly estimated tax payments
  • Establishing a sole proprietorship may be as simple as opening a bank account for the business
  • Some states and municipalities may require obtaining a license or permit


  • Like a sole proprietorship, a general partnership is not a legal entity separate from its owners
  • The difference between a sole proprietorship and partnership is that a sole proprietorship has only one owner and a partnership has two or more owners
  • Owners can take withdrawals and, if specified in the partnership, guaranteed payments • Owners pay taxes quarterly
  • Can be started through an oral agreement, though a written agreement is advisable (and required in some states)
  • Many states have legal provisions for limited liability partnerships (LLPs) that provide for some limitations on the liability of the owners and on points such as profit/loss percentages; business decisions; addition and withdrawal of a partner and terms of operation
  • Some partnership allocation structures may subject you and your business to heightened Internal Revenue Service (IRS) scrutiny
  • To form a partnership, you must register your business with your state, a process generally done through your Secretary of State’s office


  • A separate legal entity from its owners
  • Corporate documents are filed with the state and an annual fee is paid
  • Separate corporate bank accounts and records are created, and assets and money generated by the corporation are owned by the corporation
  • Corporations are required to pay federal, state and, in some cases, local taxes
  • Most businesses must register with the IRS and state and local revenue agencies. Although any business that has employees will need to get a tax ID number, it is required for a corporation
  • Unlike sole proprietors and partnerships, corporations pay income tax on their profits. In some cases, corporations are taxed twice — first, when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns
  • Shareholders who also are employees pay income tax on their wages. The corporation and the employee each pay one half of the Social Security and Medicare taxes, but this usually is a deductible business expense for the corporation
  • To form a corporation, you must file articles of incorporation with your state, a process generally done through your Secretary of State’s office


  • A corporation with the Subchapter S designation from the IRS
  • To be considered an S corp, you must first charter a business as a corporation in the state where it is headquartered
  • An S corp is different from a C corp in that its profits and losses can pass through to the owner’s personal tax return. Consequently, the business is not taxed itself. Only the shareholders are taxed. Losses are limited to the shareholder’s tax basis
  • Shareholders can be paid wages, receive distributions of profits or a combination of wages and distributions


  • A hybrid type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership
  • The “owners” are referred to as “members.” Depending on the state, the members can consist of a single individual (one owner), two or more individuals, corporations or other LLCs •

Unlike shareholders in a corporation, in most states LLCs are not taxed as a separate business entity. Instead, all profits and losses are “passed through” the business to each member of the LLC. LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership would

  • To form an LLC, you must file the appropriate documents with your state, a process generally done through your Secretary of State’s office
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