Selecting a Business Legal Structure

Your legal entity determines your taxes, personal liability and more

By John Riddle

When forming a new business, you need to decide on a legal structure. Will you be a sole proprietor – the most common form of business ownership? Or will you form a corporation or some other more complex entity?

The structure you ultimately choose greatly affects your business, including your tax obligations, the number and type of shareholders (owners) you are allowed to have, your personal liability for business debt and the costs of starting and running your business. Because of this, you need to choose your structure wisely.

The four main business legal structures are:
Sole proprietorship
Partnership
Corporation (S corp. or C corp.)
Limited liability company (LLC)

Compare legal structure pros and cons

When deciding which legal structure makes the most sense for your business, consider things like personal liability for business debts, access to capital, tax issues, operating formalities and allowable expense deductions. Corporations reduce personal liability, which can make it easier to attract investors, and allow for greater tax deductions. Sole proprietorships and partnerships are simpler and less costly to form and often pay less in taxes than corporations.
Try: SCORE and FindLaw.com offer tips on how to choose the right legal structure for your business, and The Company Corporation has a handy comparison chart of benefits and features.

Sole proprietorships

Many small businesses start out as a sole proprietorship, which is the oldest and least expensive form of business to launch. In fact, you don't even need to file any papers to set up a sole proprietorship. Being a sole proprietor means that business income is reported on your personal income tax returns, and you're personally responsible for any business debts.
Try: Get a basic overview of sole proprietorships along with the other common legal structures at Nolo.com. The IRS provides a chart of tax forms you may be required to file as a sole proprietorship.

Partnerships

A partnership can be formed between two or more people. Aside from creating an agreement between the partners — something that's advisable to define roles and responsibilities — no forms are required to be filed to form a partnership. Business income from a partnership is reported on personal income tax returns, and partners can be held liable for business debts.
Try: The SBA offers a look at the advantages and disadvantages of partnerships as well as an overview of the various types of partnerships you can form and the tax forms you may need to file. Purchase partnership agreement forms at UrgentBusinessForms.com

Corporations

To form a corporation, you need to file forms and pay fees. Business income needs to be reported on corporate tax returns rather than on personal income tax returns. One of the major benefits of incorporating is that it limits personal liability for business debts.
Try: Take a look at the various types of corporations (C-corporation and sub-chapter S-corporation) at IRS.gov. When you're ready to form a corporation, the folks at My Corporation.com can get you started, or download an order form and do it yourself. The Company Corporation also has complete details and can get you set up.

LLC

You'll have to file certain forms and fees to create an LLC, which is a relatively new business structure. Limited liability companies provide the liability protection of a corporation but are still taxed like sole proprietorships or partnerships.
Try: Find FAQs about the advantages and disadvantages of forming an LLC at CompaniesInc.com, which can also help you file the appropriate forms.

A sole proprietorship may be referred to as a "DBA" (doing business as).
If you start out as a sole proprietorship, you can change your structure at a later date as your business continues to grow.
Make sure you understand all of the various liabilities that are associated with each type of business structure.