You’ve launched your business. You’re generating revenue, you have some customers. But where is that revenue going? If you haven’t taken the time to set up your tax structure, you’re in a sole proprietorship (if you’re the only owner), or a partnership (if you’re working with someone who also shares ownership). This might be fine for now, but if you want to ultimately grow or scale your business, you’ll want to make a change as revenue grows.

Why change? There are three primary reasons: legal liability, tax liability, and fundraising options. In a sole proprietorship and partnership, you are the business. If someone sues the business, they’re suing you personally by default, and your personal assets are at risk. The business’s income is your income, and taxed accordingly. Money you raise to launch or grow your business is also taxable in some instances.

So why not incorporate immediately? Well, maybe you should, but depending on your assets and cash on hand, that’s might not be the right answer. Incorporating isn’t free, it costs money and takes time, to varying degrees based on the structure. And even if you still want to incorporate immediately, which structure should you choose?

The Short Answer

There are a number of business structures to choose from, and it’s possible that any one of them might be the true best fit at the moment for you and your company. Read about each type and who it’s for further below. However, the short answer is your company probably fits into one of these three boxes:

If you have no revenue at all, and/or own no personal assets and are at low risk for a lawsuit:
You’re probably fine as a sole proprietorship or partnership for the moment.

If you have any revenue at all:
You should probably form an LLC.

If you have over $40,000 in annual profits:
You should probably investigate if it’s time to have your LLC taxed as an S-Corp

If you need to raise money and want to sell stock to do that:
You should probably form or upgrade to a C-Corp, but make sure you’re really ready.

Now, each company is different, and some might grow through each of these structures one at a time in order, while others might skip some, or stay at one structure through their exit strategy. None of these are wrong approaches, as the needs for each business, and goals for each founder, are different.

So, with that context, let’s get into the longer answer and explore the various business structures in more detail.

What are the Major Types of Business Structures?

We’ll be discussing the five most common business structures here, the sole proprietorship, general partnership, limited partnership, LLC (as well as LLC taxed as S-Corp), and corporation.

Note that when it comes to information about costs, these don’t include the costs associated with some industries that require licensing and registration. Each state also has unique rules and fees associated with many of these types, which you can learn about by going to this website, finding your state’s website, and clicking in their services or business entities section.

Further, if you want to have employees, you’re still required by law to register your business with your state and obtain an EIN.

Sole Proprietorship

This is the most common business structure in the United States, largely because there is no upfront cost or bureaucracy in order to launch one. If you say you’re in business, but haven’t done any sort of paperwork to register a business, congratulations, you have a sole proprietorship.

The bottom line is, if you’re a business that wants to grow and one day scale, you don’t want to remain a sole proprietor for very long. It adds a ton of unnecessary risk. If someone has cause to sue your business, they can come after your personal assets. There is no protection or barrier between you and your business. Moreover, potential partners, lenders, and investors might not take you as a “serious” business entity. It’s also really cheap and easy to set up an LLC, which is going to be a much, much better option for most entrepreneurs.

What does it cost? It costs absolutely nothing for most folks.

What kind of business is it for? A lot of freelancers and independent contractors run their businesses as sole proprietorships (at least to start, though in some industries, it’s still a good idea to transition to an LLC at some point to avoid liability). New businesses that haven’t had a moment to incorporate as a proper entity yet might temporarily be in this stage, particularly if it’s a business you run out of your home. This is also a perfectly fine business structure to be in for most businesses pre-revenue.

What’s the upside? Easy and free to start, easy to exit or dissolve. There are some special tax deductions that might be helpful to certain industries or early on in your business. There is also no annual reporting requirement for the business, which means you don’t have to publicly disclose as many details about your business.

What’s the downside? In a word: liability. In a sole proprietorship, there is no wall between you, your personal assets, and your business. If sued, you can lose your house, car, savings, business assets, etc. It can be very difficult to access capital as a sole proprietor. It also has an increased risk for being audited by the IRS according to recent data.

How do the taxes work? There is no separation between you and your business. For tax purposes, business income is your income. You’re likely to spend a lot of time itemizing deductions and looking for special deductions come tax season. You also must pay self-employment tax, with contributions to Medicare and social security. All your business income is subjected to self-employment tax of 15.3%, in addition to state and federal income taxes.

Limited Partnership

The limited partnership is similar to a sole proprietorship in most ways, except that there are multiple owners, each called a partner. For at least one of the partners, they face all the liability owning a sole proprietorship comes with, and manage the day-to-day operations. The other partners (often called “silent partners”) have limited liability, but also generally have limited control over the company, and are typically investors. Again, similar to the sole proprietorship, it also “passes through” income, so the business itself doesn’t do its taxes as a unique entity, and profits and losses are instead passed through to the partners, who report it on their personal income tax.

Generally speaking, you don’t want to remain in a limited partnership for very long because of the liability risk. Upgrading to a limited liability partnership, or perhaps another structure that better protects you should be a priority the moment you’re generating significant revenue (in excess of $5,000 annually), or any revenue if your product or service has potential liability risk.

What does it cost? It costs absolutely nothing, unless you want to consult a lawyer to draw up or look over the details of the limited partnership before agreeing to terms. If the partnership split is simple to understand and relatively even, this probably isn’t necessary.

What kind of business is it for? If you’re in business with a partner, you probably start out with a handshake and have a limited partnership. Generally, you don’t want to stay a limited partnership for very long, because of the liability risk it incurs.

What’s the upside? Easy and free to start. Still a pass-through entity, which means partners take tax free distributions subject to personal income tax.

What’s the downside? Like the sole proprietorship, liability is a problem. There is no wall between you, your personal assets, and your business. If sued, you can lose your house, car, savings, business assets, etc. It can be very difficult to access capital, also. The business can also dissolve upon the death or exit of a partner, no matter if the other partners want it to or not.

How do the taxes work? There is no separation between you and your business. For tax purposes, what income you receive as a partner from the business is your income. You’re likely to spend a lot of time itemizing deductions. You also must pay a 15.3% self-employment tax, with contributions to Medicare and social security.

Limited Liability Corporation (LLC)

The limited liability corporation (LLC) marries the owner control of sole proprietorships and partnerships with the liability protection of corporations. It’s also advantageous for tax purposes once it hits a certain dollar amount of profits. The entrepreneur community is often very gung-ho about forming an LLC early to mitigate liability risk, and they’re generally not wrong.

The bottom line is that an LLC protects your personal assets, keeps you in control of your business, and is ready to grow and scale. But, it’s not free, and requires some extra costs and attention paid to accounting practices and tax filing.

What does it cost? The initial filing fee costs between $35 and $500 depending on the state, with annual fees between $0 and $500. There are also extra annual taxes and reporting fees, which can add up. Investigate your state’s fees, franchise taxes, and other costs on your local Secretary of State’s website. You’ll also probably want professional accounting services at some point, which might cost between $500 and $3,000 a year.

What kind of business is it for? LLCs are generally the best bet for most businesses where the owner wants to retain full control while gaining liability protection. Some experts suggest forming an LLC from day 1 just to avoid the liability issue, but LLCs are not free, or even cheap in some states (despite the many websites advertising forming an LLC for free). How long you wait is up to you, what level of liability risk you’re comfortable with, and when you can afford the costs of an LLC. If you have a product or service that lends itself to potential lawsuits, it’s best to get that protection earlier rather than later. If you feel your risk of a suit is very low (or near zero because you don’t have customers yet), you might wait until your revenue is at least triple the cost of forming and maintaining the LLC.

What’s the upside? Liability protection and control are the biggest advantages to an LLC. They’re somewhat simple to start, though there is a compliance element that will take some time out of the year. LLCs are still a pass-through entity, which means partners take tax-free distributions later taxed as personal income. Some income can benefit from some tax savings. There is also an air of professionalism associated with an LLC or other form of corporation. An LLC is also a separate entity from the owner, which can make acquiring loans easier than it might be for an individual owner of a sole proprietorship.

What’s the downside? LLCs are not free, and there are some costs and time associated with forming and maintaining them. In some states, LLCs can only last 5 years, at which point they need to reincorporate. They also don’t have the capital raising ability to sell stock that other corporations possess. They are also still partially subject to self-employment tax.

How do the taxes work? This is a pass-through entity, and any profits are claimed on personal income taxes. However, there are two types of income owners receive from an LLC, there is a salary (the IRS requires you pay yourself a “fair” salary, usually a third of net profits, and then there are dividends (sometimes called distributions). Only the salary portion of income is subject to self-employment tax, creating 15.3% savings on taxes on any money taken as a dividend. This is of course offset by the costs of the LLC and any franchise taxes and fees, but so long as profits are higher than $50,000 or so, this is usually a net positive.

LLC taxed as an S-Corporation

LLCs can opt to get taxed as an S-Corp if they qualify, allowing businesses to qualify for certain tax benefits that can lead to more savings, particularly through the use of retirement accounts. This is different than forming an actual S-Corp, which requires organizing your business like a corporation with a board of directors and officers.

Having your LLC taxed as an S-Corp tends to cost more than an LLC, and most experts recommend running projections with your tax and accounting professional to see if there would be a net financial benefit when the business starts earning $40,000 to $100,000 or more in annual profits.

Limited Liability Partnership (LLP)

The limited liability partnership (LLP), sometimes called a general partnership, provides a lot of the benefits of a partnership with more of the protections of an LLC. The liability risk inherent to sole proprietorships and limited partnerships is also less of a problem here. If someone sues a partner, you are not also liable for their actions. A lot of businesses might stay in this structure for the life of the business.

What does it cost? The initial filing fee is usually around $100 per partner, and sometimes must be repaid annually, but this varies by state.

What kind of business is it for? Limited Liability Partnerships are great for certain professional service industries, like law firms or investment firms, where each partner brings a pool of clients, and they can pool administrative and other resources with their fellow partners. It’s also attractive to such professional service industries because partners aren’t able to be held liable for the actions of other partners, and their personal assets are more protected.

What’s the upside? A measure of liability protection is the biggest advantage to an LLP. Relatively simple to start. Still a pass-through entity, which means partners take tax-free distributions later taxed as personal income.

What’s the downside? The business can dissolve upon the death or exit of a partner. This is also a more formal partnership, and requires some form of written agreement and some annual reporting requirements (check your secretary of state’s website for details). The liability protection for yourself and your own actions as a partner isn’t absolute, and can vary by state. It’s important to examine the details in your specific state to ensure you understand when you have liability protection.

How do the taxes work? Like the LLC, this is a pass-through entity, where profits are distributed to partners tax-free, and claimed as income on their personal income tax. You also must pay 15.3% self-employment tax, with contributions to Medicare and social security.

C-Corporation

Also simply called a corporation, the C-Corp is a publicly traded company that can issue stock to raise capital. They also offer the most liability protection for personal assets of the owners. However, they also offer the least direct control of the company. The company is instead run by a board of directors elected by stockholders, and the officers execute the day-to-day operations.

C-Corps are attractive to those who need to raise capital to scale their business. However, they are expensive to set up and maintain, and the nature of raising capital means surrendering some control of the company to stockholders, even if you retain a majority of shares.

What does it cost? There are a number of documents that must be filed to form a C-Corp, including articles of incorporation, corporate bylaws, a shareholder’s agreement, and a stock purchase agreement. Getting legal assistance to draft and file these forms can cost $500-$1,000, in addition to filing fees that can range from $100 to $800 depending on which state you’re incorporating in. C-Corps also generally need accounting personnel.

What kind of business is it for? C-Corps are for businesses that want to raise capital by selling stock. This is generally for successful companies making a few million in annual revenue that need to raise capital for aggressive expansion with an initial public offering of stock (IPO). However, there are some newer companies that know they have a unique innovation that requires more R&D, and require major capital investment to bring to market. Often, these sorts of companies are LLCs that seek more traditional investors that help take them through the initial public offering (IPO).

What’s the upside? The ability to fundraise by issuing stock, as well as the ability to defer profits and losses to later tax years are huge advantages of a C-Corp. Major stockholders can also benefit from stock buybacks, dividend payments, take out tax-free personal loans against their stocks as an asset, and more. C-Corps also have the strongest liability protection.

What’s the downside? C-Corps cost more, requiring more investment in payroll and accounting personnel, suffer from double taxation, and are subject to strict filing and disclosure requirements. The owners also have far less control over the company, either ceding control entirely or acting as part of a board of directors or one of the officers responsible for day-to-day operations, though there are even ways to be ousted from such a position despite forming the company.

How do the taxes work? C-Corps are not passthrough entities. Instead, all business is subject to a 21% business tax before distributing it as income to employees, which is taxed again, known as double taxation. Sometimes C-Corps spend profits as dividend payments to all stockholders, which is taxed as personal income. Sometimes stock shares are part of compensation, which aren’t taxed until they’re sold/realized. C-Corps also have the power to defer certain tax benefits or liabilities for future returns, which can reduce the overall tax burden if applied strategically. The taxes for C-Corps generally require tax professionals to navigate.

What Else is There?

There are other structures out there, most created for specialized types of organizations. These are less common, but might be the perfect fit for your business, and are worth investigating to see if they align with your plans for your company.

Nonprofit

The nonprofit track, and the various different types of nonprofits are so different, they’re beyond the scope of what we can do in this article. If your organization can function as a nonprofit, there are tax benefits to being one. However, the exit strategies available to nonprofits are very different. Nonetheless, you can still take a salary, and there are opportunities for corporate partnership and donations that can widen the scope of your operations that just aren’t as readily available to for-profit enterprises.

Benefit Corporation (B-Corp)

The B-Corp, or benefits corporation is functionally the same as a C-Corp, and taxed as a C-Corp or S-Corp. However, B-Corps do empower owners to exert control when incorporating to a corporate structure in areas considered to benefit the public good. This is something C-Corps aren’t generally known for, largely due to their fiduciary responsibility to shareholders to maximize profits. B-Corps empower the boards of directors to pursue environmental sustainability or other interests in the public good, even at the expense of optimized profits. Becoming a B-Corp doesn’t yet yield any additional tax breaks, and requires third party certification and auditing. Still, B-Corps have been exploding in popularity since 2006 as a way to signal shared values to customers.

Cooperative (Co-Op)

Cooperatives, or Co-Ops, are a unique business structure that allows members to pool resources to tackle specific challenges. Most people’s familiarity with co-ops are for homeowner’s associations or condo associations. However, co-ops can make sense for all sorts of companies, including worker-owned companies, farmer producing co-ops, and purchasing co-ops where members can pool their money to take advantage of bulk purchasing.

Are You Ready To Grow Your Business?

No matter what structure your business has right now, there’s a program at Bunker Labs that can help you reach the next level!

Breaking Barriers in EntrepreneurshipBreaking Barriers in Entrepreneurship is a virtual workshop series that facilitates business growth and support within AAPI, Black, Latinx, and female veteran and military spouse communities. The eight-week workshop is designed to create an immediate impact for early to growth-stage businesses by providing access to business tools, resources, capital opportunities, mentorship, and a stronger peer network.

Veterans in ResidenceVeterans in Residence is a professionally facilitated, 16-week business incubator that provides veteran and military spouse entrepreneurs a networking community, business skills, and opportunities to help grow their business.

CEOcircleCEOcircle is a monthly peer accountability group for growth-stage companies looking to scale. The year-long program builds a brain-trust of peers scaling and growing their companies and as CEOs through education, connections, and mentorship.

The Ambassador Program: The Ambassador Program is a 12-month volunteer program that helps develop and connect the local entrepreneurial ecosystem. Ambassadors ensure there is a clear path for Bunker Labs entrepreneurs to access the local resources and networks they need to successfully launch and grow their businesses.

Bunker Labs is Now Part of IVMF

As of January 2024, Bunker Labs is now a part of Syracuse University’s D’Aniello Institute for Veterans and Military Families (IVMF). In addition to ongoing Bunker Labs programming, we’d encourage you to browse IVMF’s deep wealth of entrepreneurship programming, much of it available virtually or at locations across the country. Find the program to help your business take the next step today!