Understanding Business Structures
October 5, 2020
A business structure is a category of organization that is legally recognized in a given jurisdiction and characterized by the legal definition of that particular category. An organizational business structures defines how activities such as task allocation, coordination, and supervision are directed toward the achievement of organizational aims. Organizational business structures affect organizational action and provides the foundation on which standard operating procedures and routines rest.
A normal corporate structure consists of various departments that contribute to the company's overall mission and goals. Common departments include Marketing, Finance, Operations management, Human Resource, and IT. These five divisions represent the major departments within a publicly traded company, though there are often smaller departments within autonomous firms. There is typically a CEO, and Board of Directors not usually composed of the directors of each department. There are also company presidents, vice presidents, and CFOs. There is a great diversity in corporate forms as enterprises may range from single company to multi-corporate conglomerate. The four main corporate structures are Functional, Divisional, Geographic, and the Matrix. Realistically, most corporations tend to have a “hybrid” structure, which is a combination of different models with one dominant strategy.
“The business structure you choose influences everything from day-to-day operations, to taxes, to how much of your personal assets are at risk. You should choose a business structure that gives you the right balance of legal protections and benefits.”
In this discussion, we will review seven common business structures:
1. Sole Proprietorship
3. Limited Liability Company (LLC)
4. Corporation C (C-Corp)
5. Corporation S (S-Corp)
6. Corporation B (B-Corp)
7. Non-Profit Corporation
1. SOLE PROPRIETORSHIP
A sole proprietorship is easy to form and gives you complete control of your business. You are automatically considered to be a sole proprietorship if you do business activities but do not register as any other kind of business.
Sole proprietorships do not produce a separate business entity. This means your business assets and liabilities are not separate from your personal assets and liabilities. You can be held personally liable for the debts and obligations of the business. Sole proprietors are still able to get a trade name. It can also be hard to raise money because you cannot sell stock, and banks are hesitant to lend to sole proprietorships.
Sole proprietorships can be a good choice for low-risk businesses and owners who want to test their business idea before forming a more formal business.
Partnerships are the simplest structure for two or more people to own a business together. There are two common kinds of partnerships: limited partnerships (LP) and limited liability partnerships (LLP).
Limited partnerships have only one general partner with unlimited liability, and all other partners have limited liability. The partners with limited liability also tend to have limited control over the company, which is documented in a partnership agreement. Profits are passed through to personal tax returns, and the general partner — the partner without limited liability — must also pay self-employment taxes.
Limited liability partnerships are like limited partnerships but give limited liability to every owner. An LLP protects each partner from debts against the partnership, they will not be responsible for the actions of other partners.
Partnerships can be a good choice for businesses with multiple owners, professional groups (like attorneys), and groups who want to test their business idea before forming a more formal business.
3. LIMITED LIABILITY COMPANY (LLC)
An LLC lets you take advantage of the benefits of both the corporation and partnership business structures.
LLCs protect you from personal liability in most instances, your personal assets — like your vehicle, house, and savings accounts — will not be at risk in case your LLC faces bankruptcy or lawsuits.
Profits and losses can get passed through to your personal income without facing corporate taxes. However, members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security.
LLCs can have a limited life in many states. When a member joins or leaves an LLC, some states may require the LLC to be dissolved and re-formed with new membership — unless there is already an agreement in place within the LLC for buying, selling, and transferring ownership.
LLCs can be a good choice for medium- or higher-risk businesses, owners with significant personal assets they want to be protected, and owners who want to pay a lower tax rate than they would with a corporation.
4. CORPORATION C (C-CORP)
A corporation, sometimes called a C corp, is a legal entity that is separate from its owners. Corporations can make a profit, be taxed, and can be held legally liable.
Corporations offer the strongest protection to its owners from personal liability, but the cost to form a corporation is higher than other structures. Corporations also require more extensive record-keeping, operational processes, and reporting.
Unlike sole proprietors, partnerships, and LLCs, corporations pay income tax on their profits. In some cases, corporate profits are taxed twice — first, when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns.
Corporations have a completely independent life separate from its shareholders. If a shareholder leaves the company or sells his or her shares, the C corp can continue doing business relatively undisturbed.
Corporations have an advantage when it comes to raising capital because they can raise funds through the sale of stock, which can also be a benefit in attracting employees.
Corporations can be a good choice for medium- or higher-risk businesses, businesses that need to raise money, and businesses that plan to "go public" or eventually be sold.
5. CORPORATION S (S-CORP)
An S corporation, sometimes called an S corp, is a special type of corporation that is designed to avoid the double taxation drawback of regular C corps. S corps allow profits, and some losses, to be passed through directly to owners' personal income without ever being subject to corporate tax rates.
Not all states tax S corps equally, but most recognize them the same way the federal government does and taxes the shareholders accordingly. Some states tax S corps on profits above a specified limit and other states do not recognize the S corp election at all, simply treating the business as a C corp.
S corps must file with the IRS to get S corp status, a different process from registering with their state.
There are special limits on S corps. S corps cannot have more than 100 shareholders, and all shareholders must be U.S. citizens. You will still have to follow strict filing and operational processes of a C corp.
S corps also have an independent life, just like C corps. If a shareholder leaves the company or sells his or her shares, the S corp can continue doing business relatively undisturbed.
S corps can be a good choice for a businesses that would otherwise be a C corp, but meet the criteria to file as an S corp.
6. CORPORATION B (B-CORP)
A benefit corporation, sometimes called a B corp, is a for-profit corporation recognized by a majority of U.S. states. B corps are different from C corps in purpose, accountability, and transparency, but are not different in how they are taxed.
B corps are driven by both mission and profit. Shareholders hold the company accountable to produce some sort of public benefit in addition to a financial profit. Some states require B corps to submit annual benefit reports that demonstrate their contribution to the public good.
There are several third-party B corp certification services, but none are required for a company to be legally considered a B corp in a state where the legal status is available.
7. NON-PROFIT CORPORATION
Nonprofit corporations are organized to do charity, education, religious, literary, or scientific work. Because their work benefits the public, nonprofits can receive tax-exempt status, meaning they do not pay state or federal taxes income taxes on any profits it makes.
Nonprofits must file with the IRS to get tax exemption, a different process from registering with their state.
Nonprofit corporations need to follow organizational rules very similar to a regular C corp. They also need to follow special rules about what they do with any profits they earn. For example, they cannot distribute profits to members or political campaigns.
Nonprofits are often called 501(c)(3) corporations — a reference to the section of the Internal Revenue Code that is most commonly used to grant tax-exempt status.
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