Two very common questions we often receive from business owners include, “what are the types of business structures,” or, “how should I structure my business?” and “should I change the structure of my business?” Your business structure provides a backbone for your company and determines how much you can expect to pay in taxes, how much money your business will be able to raise, and the paperwork that you will be required to file. Some business structure options include C-Corp, S-Corp, and LLCs (made up of a sole proprietorship or a partnership).
In 2021, many business owners are looking for a way to capitalize on shifting market conditions. For new and existing businesses, choosing to structure or restructure your company is the first step toward developing a solid tax strategy.
Here at Granite Mountain Accounting, we encourage most new and existing business owners to structure their company as a limited liability company (LLC). LLCs include sole proprietorships – businesses owned by one person – and partnerships – businesses run by multiple members. Both options typically protect business owners from personal liability and offer flexibility in sharing profits.
The Difference Between Sole Proprietorship and Partnership
Sole proprietorships are the simplest and most common structures for startup businesses and successful long-term companies. Over 73% of all businesses in the U.S. operate as a sole proprietorship compared to just 8% that operate as a partnership. However, both options come with notable advantages and disadvantages. When choosing between the two, business owners must remember that outside factors such as economic hardships and growth beyond expectation can have an impact on the success of the business structure they choose.
Although it’s important to seek professional assistance before deciding to structure or restructure your business, we‘ve listed a few pros and cons for each type of LLC that might help you consider which is right for you and your company.
The Pros and Cons of Sole Proprietorship
A sole proprietorship is owned and operated by one individual who oversees the company’s profits, debts, liabilities, and losses. While this business structure is easy and inexpensive to adopt, it comes with increased individual responsibility. Companies that may benefit from this structure include those that operate on a seasonal or part-time basis, those with little liability, those intended to operate for the owner’s life only, and those based at home.
Pros
- There is no requirement for a formal creation process
- Easy to set up, operate, and dissolve
- No separate tax return
- Easy to integrate business use of home deductions
- No double taxation of profits
Cons
- No liability protection (except through insurance)
- Self-employment tax is assessed on the entire profit of the business
- Transfer of ownership can be complex
- Limited access to fringe benefits for owners
The Pros and Cons of a Limited Liability Partnership (LLP)
LLP’s limit liability for business partners. This means that any debt incurred by individual employees will not fall on others. Businesses that typically benefit from this structure include those with partners not actively involved with the company, those with equity capital needs, and those with exposure to liability.
Pros
- Liability protection for limited partners
- A separate entity from partners
- Ownership can be transferred within the rules of the partnership agreement
- Partners’ liability is limited to their investment in the business
- Limited partners pay self-employment tax on guaranteed payments only
- No double taxation of profits
Cons
- There must be one general partner with unlimited liability
- Limited liability status for damages can be lost for a variety of administrative reasons
- Restrictions on partners based on the entity type
- Requires a separate tax return
- Requires tracking of the basis for partners both inside and outside the partnership
Choosing the right type of business structure is important. Whether choosing to structure your business or restructure an existing company, Granite Mountain Accounting can help you decide if a sole proprietorship or LLP is right for you.
Contact us to discuss your options, needs, and priorities today.
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