Choosing the Right Business Structure

The structure you choose determines who is personally on the hook for business debts, how profits are taxed, what paperwork you file, and how easily you can bring in investors. You can change structures later, but doing it early is far simpler and cheaper.

Sole Proprietorship

A sole proprietorship is the default when one person does business without forming an entity. There is no legal separation between you and the business: you are personally liable for every business debt, contract, and judgment, and your personal assets are exposed. Taxation is pass-through — you report income and expenses on Schedule C with your personal return and pay self-employment tax on the net profit. It is the cheapest and simplest option, appropriate for very low-risk activity, but it offers no liability protection at all.

General Partnership

A general partnership forms automatically when two or more people carry on a business for profit together. Each partner is personally liable for the partnership's obligations, including those created by another partner acting for the business — joint and several liability. Taxes are pass-through: the partnership files an information return (Form 1065) and issues each partner a Schedule K-1, and partners pay tax on their share whether or not it is distributed. A written partnership agreement covering contributions, profit splits, decision-making, and exits is essential, because state default rules rarely match what partners assume.

Limited Liability Company (LLC)

An LLC is a state-created entity that gives owners (members) limited liability: personal assets are generally protected from business debts and lawsuits, provided the LLC is adequately funded, kept formally separate, and not used to commit fraud. Taxation is flexible. By default a single-member LLC is disregarded and taxed like a sole proprietorship, and a multi-member LLC is taxed as a partnership; an LLC may also elect to be taxed as an S corporation or C corporation. LLCs require formation filings and usually annual reports and fees, but far less internal formality than corporations. This combination makes the LLC the common choice for small and mid-sized businesses.

C Corporation

A C corporation is a separate legal and tax entity owned by shareholders and run by officers under a board of directors. Shareholders enjoy limited liability. The trade-off is double taxation: the corporation pays federal corporate income tax on profits (currently a flat 21 percent), and shareholders pay tax again on dividends they receive. Corporations must observe formalities — bylaws, a board, recorded meetings, stock records — and file corporate returns. C corporations are preferred where outside investment is planned, because venture investors typically require corporate stock, multiple share classes, and, frequently, Delaware incorporation.

S Corporation

An S corporation is not a separate entity type but a federal tax election available to eligible corporations and LLCs. It preserves limited liability while making income pass through to owners, avoiding entity-level federal tax. Its practical appeal is self-employment tax: owner-employees must be paid reasonable compensation subject to payroll taxes, while remaining profits are distributed without self-employment tax. Eligibility is restrictive — generally no more than 100 shareholders, only individuals and certain trusts and estates as shareholders, U.S. residency or citizenship, and only one class of stock. Payroll and additional filings add administrative cost, so the savings must justify the overhead.

Limited Partnership and Limited Liability Partnership

A limited partnership (LP) has at least one general partner with management control and personal liability, plus limited partners who invest and share profits with liability capped at their investment, as long as they stay out of day-to-day management. LPs are common in real estate and investment funds. A limited liability partnership (LLP) gives all partners protection from the partnership's obligations and, in most states, from other partners' malpractice; many states restrict LLPs to licensed professionals such as attorneys, accountants, and architects. Both are pass-through for tax purposes.

Factors to Weigh

• Liability exposure: how likely is a claim, and would personal assets be at risk without an entity?
• Tax treatment: pass-through versus corporate tax, self-employment tax, and your state's own entity taxes and fees.
• Outside investment: whether you will need venture capital, multiple share classes, or an equity incentive plan.
• Number and type of owners, and whether any are non-U.S. persons or entities.
• Administrative burden and cost: formation fees, annual reports, payroll, recordkeeping, and separate tax filings.
• Exit plans: how ownership transfers, and how a future sale would be taxed.
• State-specific rules: entity availability, franchise taxes, and licensing requirements differ by state.

Because entity choice couples legal and tax consequences, most founders benefit from a short conversation with both a business attorney and a tax professional before filing. Kensik Law can connect you with an independent licensed attorney who handles business formation.