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Choosing the Right Business Structure

At a Glance

Main Takeaway

Choosing the proper business structure is a necessary part of starting or restructuring your business. The legal structure you choose influences your company’s operations, finances, and personal liability, making understanding your options crucial. 

Next Step

Partner with Windes for business structure planning to determine the right operating structure for your company.


Types of Business Structures

A legal business structure or entity is a government classification regulating your tax burden or liability. When choosing a business structure, understanding the different business structure types is critical to ensure you get the right balance of legal protection and tax benefits.

When starting a business in California, deciding which business structure is best can be confusing. Knowing your long-term business goals, the benefits of each structure, and how each can be taxed will help you make the right decision.


Sole Proprietorship

A sole proprietorship is the most straightforward and common business structure, with the U.S. Census reporting that in 2019, 86% of non-employer businesses were sole proprietorships. It is a relatively inexpensive way to get a business up and running.

This type of business is operated and owned by a single individual, meaning you have complete control over the company’s operations and decision-making. A sole proprietorship requires no formal federal registration or legal documentation, making it easy and inexpensive to set up. Some states, counties, or cities may have registration requirements dependent on business type (i.e., restaurants).

As the sole owner, you are personally responsible and liable for all aspects of the business, including its finances, legal liabilities, and day-to-day operations. Additionally, all profits and losses of the company are reported on your personal tax return. While this can simplify the tax process, it also means that you are personally liable for any debts or legal actions taken against the business.



A partnership is a business structure that involves two or more people sharing ownership of a business. Each partner contributes to the business and splits profits and losses. The most common partnerships are general partnerships and limited partnerships.

  • General Partnership: In a general partnership, each partner is equal in management authority and is personally liable for the partnership’s debts and obligations.
  • Limited Partnerships: In a limited partnership, one or more partners manage the business and are personally liable for its debts and obligations. One or more limited partners contribute capital (sleeping or silent partners) but do not participate in the management and have limited liability.

Partnerships are a great option because they are easy to set up and manage, you can split the financial burdens and risks, and each partner can bring unique talents or capital to the business. Disadvantages include being personally liable for debts and obligations, potential conflicts over decisions, and limited ability to raise capital.


Limited Liability Company (LLC)

A limited liability company (LLC) is a legal structure that offers personal liability protection to its owners while providing flexibility and tax benefits. Unlike a sole proprietorship, an LLC is a separate legal entity, meaning that the owners, known as members, are not personally responsible for the company’s debts or legal obligations.

An LLC can have a pass-through entity tax structure, meaning that profits and losses are reported on the members’ personal tax returns, much like a partnership or sole proprietorship. However, an LLC can also elect to be taxed as a corporation, providing separate tax benefits.

The primary advantage of an LLC is that it offers a great deal of flexibility in terms of management and ownership structure, allowing members to tailor the company to their specific needs and preferences. This structure is an excellent option for personal liability protection, flexibility, and potential tax benefits.


S Corporation

An S corporation is a type of corporation that is taxed like a partnership. The business is a separate legal entity, and profits and losses pass through to the owners’ personal income. However, an S corporation has certain restrictions, such as a limit on the number of shareholders and that all shareholders must be U.S. citizens or residents.

S corporations are a common choice for small business owners because they offer the liability protection of a corporation with the tax benefits of a partnership. However, the administrative and legal requirements for setting up and maintaining an S corporation can be slightly more complex than other business structures.


C Corporation

As a C corporation, the business is a separate legal entity from its owners. This means the owners are not personally liable for any debts or legal issues the company may face. Additionally, C corporations can issue stock, meaning they can raise capital through investors.

C corporations are a good option for businesses with high liability risks or those planning to go public. However, C corporations are subject to double taxation for owners, which means that the company pays taxes on its profits, and the owners pay taxes on personal income from the business. Additionally, C corporations are subject to more administrative and legal requirements than other business structures.


What to Consider When Choosing a Business Structure

When selecting your business structure, there are several factors to consider. Tax implications, risk tolerance, and long-term goals all impact the success of your business and determine the IRS rules and reporting requirements you must follow.


Tax Implications

The tax implications of different business structures vary significantly. The owner reports all business income and expenses on their personal tax return in a sole proprietorship. This means the business’s profits are subject to income and self-employment taxes, which can burden the owner.

In a partnership, the partners’ income and expenses are divided and reported on their personal tax returns. Each partner pays income and self-employment taxes on their share of the profits.

An S corporation is a business structure that is considered a pass-through entity. Like sole proprietorships and partnerships, they undergo taxation as pass-through entities, allowing the owners to report income and expenses on their personal tax returns.

LLCs are considered hybrid entities. Depending on the elections made by the owner(s), they can pay taxes like a pass-through entity or a C corporation. A C corporation pays its income tax on its profits, and the owner(s) only pays personal income tax on the income they receive from the company.

In deciding between a California LLC or an S corporation, you may see tax savings if you opt for an S corporation structure, especially if your company’s profits exceed your personal income tax bracket.


Risk Tolerance

When choosing a business structure, you must consider your risk tolerance. Risk tolerance refers to how much uncertainty and potential loss you are willing to accept in pursuit of potential gains.

For example, a sole proprietorship carries a high degree of risk because the owner is personally liable for the company’s debts and legal obligations. If the business fails or faces legal action, your personal assets, such as your home or savings, could be at risk. A sole proprietorship may not be your best option if you have a low-risk tolerance or significant personal assets.

A corporation offers limited liability protection to its shareholders. If the company faces legal action or incurs significant debt, the shareholders are not personally responsible for the company’s liabilities. However, corporations also have a higher degree of regulation and may require more formal documentation and governance structures, which can be more costly and time-consuming. A corporation may be a good option if you have a high-risk tolerance or want to attract outside investors.

LLCs offer a middle ground between sole proprietorships and corporations. They provide their members with personal liability protection while offering flexibility and potential tax benefits. If you have a moderate risk tolerance or are looking for a business structure that balances liability protection with flexibility and ease of operation, an LLC may be a good option.


Management Structure

Structuring a business with multiple owners is more complex than setting up a sole proprietorship. In a partnership, the division of profits and other key decisions are typically governed by agreements established at the outset.

These agreements can specify how profits are divided and what happens in the event of the retirement, disability, bankruptcy, or death of a partner. Creating a partnership agreement outlining each partner’s roles and responsibilities can help prevent disputes and ensure everyone is on the same page.

Laws regarding S corporations or C corporations require a board of directors to oversee the company’s direction on behalf of the shareholders. This board makes significant business decisions and appoints officers to manage the company’s day-to-day operations.

An LLC structure generally offers more flexibility when it comes to management. LLCs can be managed by members or overseen by a management team, including members and non-members. You can draw up an operating agreement to specify the roles and responsibilities of each member, creating a clear understanding of who is responsible for what.


Payment Structure

As a small business owner, you will pay yourself and your employees a salary or draw, depending on the organization’s structure. Draws are the typical payment method for unincorporated entities. You do not withhold employee taxes for draws, which means you are responsible for paying self-employment tax to cover Social Security and Medicare taxes. You will also need to pay quarterly estimated taxes.

As an S or C Corp, you will receive a salary if your business is incorporated and you actively work there. You will receive dividends if you are not actively working in your corporation. You can receive a salary and distributions for businesses structured as an S Corp.

While the difference may seem slight, how you pay yourself can impact your tax obligations. So, consider your options and consult a tax professional with any questions or concerns.


Long-Term Business Goals

Your long-term goals for the company will affect the business entity type you choose. Once you set up your business structure, you cannot change it without reorganizing, which means starting over in terms of determining and filing for the entity type. When selecting your structure, consider your goals for three, five, ten, or even fifteen years.

A C corporation may be the best fit if you are looking for rapid growth, which typically requires significant capital. C corporations allow for multiple classes of stock and do not limit the number or type of shareholders. This is a good option if you plan to seek venture capital investments as a private company.

Consider what will happen to your business if you or another owner dies, goes bankrupt, or withdraws. While corporations can continue operating after such an event, other business structures typically dissolve unless an exit plan exists.

Plan for the long-term sustainability of your business and ensure that the structure you choose can adapt to changes and challenges that may arise over time. Consulting with a business planning professional can help you navigate exit planning strategies and make the best decision for your unique circumstances.


Administrative Complexity

Administrative complexity refers to how much paperwork and compliance requirements are associated with a particular business structure. Typically, the larger your business structure, the more complex it becomes in an administrative sense.

Sole proprietorships and partnerships generally require the least paperwork, as they do not have to file separate tax returns or keep extensive records of meetings and decision-making. However, they must still comply with basic regulations and keep track of business expenses and income.

Corporations have a more complex set of administrative responsibilities. They must file separate tax returns and keep detailed records of their financial activities, including the board of directors meetings and shareholder decisions.

Limited liability companies (LLCs) have administrative requirements similar to corporations, such as filing articles of organization and annual reports with the state. However, LLCs have more flexibility regarding management structure and tax treatment.

Consider the administrative burden of each entity when deciding which structure to choose because it affects the time and resources required to maintain the business.

Determine the Right Business Structure for Your Company

Choosing the proper business structure is essential to your future operations as a small business owner. However, choosing your entity type requires in-depth knowledge of tax and legal liabilities that can be difficult to understand.

Windes is a business advisory firm that works with small business owners in California to determine the best structure for their organization. As part of our business structure planning services, our experienced professionals will take the time to understand your business goals, assess your risk tolerance, and recommend the right entity type for your specific needs.

Contact Windes today. Let us help you determine the right business structure for your company’s future exponential growth.


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