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This article titled ‘Business Structure and Its Types’ is written by Mayank Shekhar and discusses the structure of a business and its various types.
The company structure selected has an impact on everything from daily operations to taxes and the amount of personal property at risk. One should choose a company structure that strikes a balance between legal safeguards and advantages.
I. Introduction: Business Structure and Its Types
The term “business structure” refers to the recognized legal structure of an organization in a certain country. The legal structure of a company is critical in determining the kind of activities it may engage in, such as capital raising, accountability for business commitments, and the amount of taxes owed to taxing authorities.
Before deciding on a legal structure, company owners should evaluate their requirements and objectives and get familiar with the characteristics of each business form. In the United States, the four primary business structures are sole proprietorship, partnership, limited liability company, and corporation.
II. Different Business Structures
The following sections examine the various company structures in detail:
1. Sole Proprietorship
A sole proprietorship is the simplest business form; it consists of a single person who is responsible for the company’s day-to-day operations. Additionally, the business’s revenue and expenditures are included in the owner’s tax return.
Due to the fact that the company does not exist as a distinct legal entity from its owner, it is not needed to submit separate income tax returns. Form 1040 must be filed by the owner, and it must contain Schedule C and Schedule SE for self-employment tax.
There are many benefits to operating a company as a single proprietorship. To begin, it is very cheap to establish, and there are few costs associated with establishing a sole proprietorship. The only expenses involved with establishing a sole proprietorship are company taxes and operating license fees in the majority of states.
Additionally, business owners may be entitled to tax deductions for expenses such as health insurance. In contrast to a limited liability corporation, a sole proprietorship is not subject to continuing obligations such as shareholder meetings, voting, or election of directors.
On the negative, since the company is not legally distinct from its owners, the owners will be personally responsible for the firm’s debts, liabilities, and responsibilities.
1.1 Advantages of Sole Proprietorship
- Owners may form a sole proprietorship quickly, simply, and affordably.
- Sole proprietorships are subject to few, if any, continuing requirements.
- A lone proprietor is exempt from self-employment tax (although he or she must pay unemployment tax on employees).
- Owners have complete freedom to combine company and personal assets.
A partnership is a kind of company organization in which two or more owners participate. It is the simplest company structure for two or more owners. A partnership is very similar to a single proprietorship. For instance, since the company does not exist as a distinct legal entity from its owners, the owners and the entity are regarded as a single individual.
Profits and losses from the company are distributed to the partners when taxes are filed, and each partner is obliged to disclose the information on Form 1065 with their personal tax returns. Additionally, partners are subject to self-employment tax, which is calculated based on their portion of the enterprise’s earnings. Form 1065 should be accompanied by Schedule K-1, which details the earnings or losses.
Numerous benefits accrue from a partnership company arrangement. There is minimal paperwork needed in forming a partnership, and the partners are not subject to the same degree of restrictions as limited liability corporations. Additionally, partnerships enjoy a unique tax treatment, with partners having to declare their portion of the business’s profit or loss on their individual income tax returns.
On the downside, partners are personally responsible for the company’s debts and liabilities, and their personal assets may be liquidated to satisfy corporate commitments. Additionally, disputes between partners may arise, resulting in the business’s activities being slowed.
2.1 Advantages of Partnerships
- Owners may simply and economically form partnerships.
- Partnerships are not required to meet annually and have minimal continuing formality.
- The majority of smaller companies benefit from advantageous tax treatment as partnerships.
- Partnerships often do not have to pay the minimal taxes that LLCs and corporations do.
2.2 Disadvantages of Partnerships
- All proprietors are personally liable for the business’s debts, losses, and obligations (except in the cases of limited partnerships and limited liability partnerships).
- Individual partners are accountable for the acts of their counterparts.
- Inadequately structured partnerships and oral partnerships may result in disagreements between owners.
A corporation is a kind of company structure that distinguishes the entity from its owners legally. It is time-consuming and costly to establish, and it requires owners to adhere to additional tax and regulatory obligations. The majority of companies use lawyers to supervise the registration process and to verify that the organization conforms with applicable state legislation.
When a company wishes to go public through the public offering of common stock, it must first be established as a corporation. Corporations must pay both federal and state taxes, while shareholders must report dividend distributions on their personal income tax returns.
Corporations are classified into two types: C-corporations and S-corporations.
A C-corporation is a legal entity distinct from its owners, while an S-corporation may have up to 100 shareholders and operates similarly to a partnership.
The capacity to raise money is one of the benefits of a company structure. The company may raise significant sums of money by selling public stock. Additionally, the company structure has limited personal responsibility, which protects the owners from the firm’s debts, responsibilities, and duties.
On the negative, a corporation is subject to more regulations than a single proprietorship or partnership, including meeting, voting, and director election, and it is more costly to establish than a sole proprietorship or partnership.
3.1 Advantages of Corporations
- Owners are immune from personal responsibility for the debts and liabilities of the business.
- Corporations benefit from a robust corpus of legal precedent that serves as a guide for owners and management.
- Corporations are the optimal form of organisation for future public businesses.
- Corporations may raise money more readily by selling securities.
- Corporations may readily transfer ownership through securities transfers.
- Corporations may exist in perpetuity.
- Corporations may generate tax advantages in some situations, but keep in mind that earnings earned by C corporations may be subject to “double taxation.”
3.2 Disadvantages of Corporations
- Corporations need yearly meetings and adherence to specific procedures by owners and directors.
- Establishing a corporation is more costly than forming a partnership or single proprietorship.
- Corporations must pay yearly fees and submit periodic reports to the state.
4. Limited Liability Partnership (LLC)
A limited liability company (LLC) is a hybrid business form that combines the advantages of both partnerships and corporations, i.e., it has the features of both. It protects company owners from personal responsibility while also lowering tax and business obligations.
Profits and losses are passed through to the owners, and each company owner is obliged to report a portion of the profits/losses on their personal tax forms.
Additionally, unlike an S-corporation, which is restricted to 100 stockholders, a limited liability company has no such restriction. When a limited liability corporation is formed, the entity must submit its articles of association with the Secretary of State in the state in which it wants to do business. The entity may be needed to submit an operating agreement in some states.
One of the benefits of forming a limited liability company over forming a corporation is that there are fewer formalities. There is less paperwork required, and owners benefit from limited liability, which prevents their personal assets from being liquidated to satisfy the entity’s obligations. No restriction exists on the number of shareholders that a limited liability corporation may designate.
On the downside, forming a limited liability company is costly, since it must register with the state in which it wants to do business. Additionally, the company may need the services of an accountant and an attorney to guarantee compliance with applicable tax and regulatory laws.
4.1 Advantages of LCC
- LLCs are not required to convene annually and have minimal continuing formality.
- Owners are immune from personal responsibility for the debts and liabilities of the business.
- LLCs benefit from partnership-style pass-through taxes, which many small companies find advantageous.
4.2 Disadvantages of LCC
- Owners and managers of LLCs lack a trustworthy body of legal precedent to assist them, but LLC law is growing more dependable over time.
- An LLC is not a suitable structure for companies that want to ultimately go public or obtain cash in the financial markets.
- Establishing an LLC is more costly than forming a partnership.
- Annual fees and frequent filings with the state are often required for LLCs.
- Certain states prohibit the formation of LLCs for certain professional occupations.