When you think about starting a business, it’s easy to get caught up in the excitement of an innovative idea, monetizing your passion project, or just being a boss.

But before you start planning your pitch on “Shark Tank,” there are some necessary, if less exciting, decisions you need to make to set your business up for success.

Among the most foundational questions when starting your business: what business structure will you use?

The importance of choosing the right business structure

Picking the right business structure is a big decision—it affects your business now and down the road. Here’s a quick look at the ways it can impact your business.

Short-term impacts:

• Taxes: Your structure determines if you file taxes with your personal return or separately for the business.
• Personal liability: How protected are your personal assets from business debts and lawsuits?
• Raising capital: Your options for investors or loans depend on your business structure.

Long-term impacts:

• Growth and flexibility: Corporations offer more room to expand but come with complex compliance; sole proprietorships are simpler to operate but more complicated to scale.
• Management control: Your structure affects who makes the decisions and how much flexibility you have.
• Exit strategy: Some structures make selling or transferring ownership easier when the time comes.

What are your business structure options?

Choosing the right structure from the start can seem overwhelming. Even serial entrepreneurs must carefully consider their options when they start a new venture.

There are several routes to take, and it’s important to look at the pros and cons of each so you can make an informed decision. No set formation will fit every circumstance or plan, but the comparison below offers a primer on your options.

Note: as you consider your options, it’s vital to consult with an attorney. They can advise you on what structure might meet your needs and help you draft the necessary paperwork and documentation to support it.

Tax Structure v. Asset Protection 

It’s Important to note there is a distinction between your asset protection entity choice (it’s a state law choice – such as Texas Corporation or Texas Limited Liability Company) versus  Disregarded Entity, Partnership, Sub S Corporation, C Corporation, which are taxation designations, which are filed with the IRS on how your business reports its income and pays taxes.  They all have their own rules. 

Limited liability company (LLC)

An LLC is a modern structure. It offers liability protection while maintaining tax flexibility. You can seek to have an LLC taxed as any of the designations with the IRS. 

Many states don’t restrict ownership, meaning anyone can be a member, including individuals, corporations, citizens of other countries, foreign entities, and even other LLCs. In Texas, however, you must have a registered agent with a physical Texas address to form an LLC. You can pay services for these things. 

Advantages of an LLC: 

• An LLC offers limited personal liability for members.
• You gain “Charging Order” protection in Texas
• You have flexibility in creating a management structure.
• LLCs have fewer formal requirements than corporations.

Potential pitfalls of an LLC: 

• There are potential limitations on transferring ownership.
• You will not be able to issue stocks or shares as an LLC
• If you intend to sell your business to private equity or go public you will need to convert entities. 

Sole proprietorship / Disregarded Entity

A sole proprietorship or disregarded entity is the simplest and most common business structure, particularly for very small businesses, consultants, and freelancers. This setup does not legally distinguish between the owner and the business,  the income and expenses are tracked on a schedule on your 1040 Tax Return.  

Advantages of a sole proprietorship:

• You will have simple tax filing because your business income will be reported on your personal tax return.

Potential pitfalls of a sole proprietorship:

• You will have to pay Self Employment Tax of 15.3%
• Your ability to raise capital for your business may be limited.
• If you decide to sell or transfer ownership of your business, it will be more challenging.

Partnership

Partnerships are unincorporated businesses owned by multiple individuals or entities. There are several types of partnerships, including general partnerships, limited partnerships (LPs), limited liability partnerships (LLPs), and limited liability limited partnerships (LLLPs). All formal Partnerships are registered with Secretary of State

Advantages of a partnership:

• The Partnership does not pay its own taxes. You will have pass-through taxation, so you won’t be subject to double taxation.

Potential pitfalls of a partnership:

• Complicated Tax Rules
• If you decide to dissolve the partnership for any reason, the process may be complex or even contentious.
• You have fewer rights as a limited partner (versus a General Partner), in limited liability partnerships. 

S corporation

An S corporation is a special type of corporation that passes corporate income, losses, tax deductions, and tax credits along to its shareholders while maintaining the liability protection of a corporation. This structure was created to encourage the formation of small and family-owned businesses as corporations by avoiding double taxation.

Advantages of an S corporation: 

• You pay yourself wages as a W-2 employee
• In both a Corporation or LLC S Corp, shareholders/members have limited personal liability. 
• You have the advantage of partial pass-through taxation.
• You can potentially gain tax savings on self-employment taxes.

Potential pitfalls of an S corporation:

• In order to maximize tax benefits you have to meet the reasonable compensation standards established by the IRS and case law
• You have to adhere to strict eligibility requirements. For example, you are limited to a maximum of 100 shareholders.
• You have limitations on stock classes (voting and non-voting)
• They should almost never own real estate, and there are issues with large amounts of depreciation. 
• S corporations have no flexibility with respect to allocating items of income and deduction not in proportion to the shareholders’ ownership interests.
• A new member that contributes property to an LLC that has made an S election may recognize taxable gain as though the property were sold to the LLC

C corporation

A C corporation is a “traditional” corporation taxed separately from its owners. It offers strong protection from personal liability but is subject to double taxation.

Advantages of a C corporation: 

• C corporations offer limited personal liability for shareholders.
• You have unlimited growth potential and can issue multiple classes of stock.
• It’s easier to attract investors and go public with this structure.
• Certain businesses may qualify for Small Business Capital Gains Exclusion under Sec. 1202 (this is a huge deal if you plan on an exit or going public). 

Potential pitfalls of a C corporation: 

• Corporations do not have “Charging Order” protection, and the shares of a stockholder may be seized in the event of a judgment. 
• You are subject to double taxation, where you are tax liable on both a corporate and individual level.
• This structure is more complex and expensive to form and maintain than the other choices.
• C corporations require extensive record-keeping and reporting.
• You need a dedicated CPA familiar with Corporation Taxation

Which business structure option is best for entrepreneurs?

You can enlist the help of legal support to guide you through making the best choice for your business. Some questions to go through with your attorney to create a strong legal foundation for your company include:

1. What are my needs?
   Consider your business goals, risk tolerance, and desired level of control. A clear understanding of these factors will guide your decision.

2. What’s my financial contribution?
   Your business structure has big financial implications, so determine how much you’re willing to invest in formation and ongoing compliance costs.

3. What’s my plan for growth?
   Do you plan to expand? Do you have family considerations you’d like to include? Talk through your long-term vision for the business and how different structures might support or hinder your goals.

4. What are my state’s requirements?
   Since business structure regulations and tax implications vary by state, getting familiar with those that might impact you is important. Don’t worry—your business attorney can help you understand what specific statutes and regulations are relevant to your business goals.

5. What’s the best path forward for me?
   Remember that you can change your structure as your company grows and evolves. The one you choose should ideally work for at least the next few years. Changing your business structure can create unnecessary complications and expenses, so it’s best to think long-term.

Find the right business structure for your business

The business structure you select at the beginning of your journey will have significant implications for taxes, liability, and operations. However, with careful consideration, expert guidance, and strategic planning, your business structure can become a cornerstone of your long-term success as an entrepreneur. 

To determine the best business structure for your goals, it’s vital to consult with a business planning attorney early on. The Law Offices of Shann M. Chaudhry, ESQ., can help you start on your road to formation. Our experienced attorneys can help take your business from an idea to reality with a tailored business structure.

Contact us to schedule a consultation to discuss how we can assist you with your entity selection.