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LEGAL DICTIONARY

Legal Structure of a Business

A legal structure is an organizational framework for how a business entity operates. Also called a business structure, a business form, or a business ownership structure, the proper legal structure depends on the size and type of your business and your business goals.

Typical business legal structures include sole proprietorships, limited liability companies (LLCs), partnerships (such as LLPs), and corporations.

Different legal structures come with distinct advantages and disadvantages. In most cases, the criteria you will evaluate to select the right format involve the following:

  • owner liability
  • expenses and procedures needed to create and run the business structure
  • how the business will be taxed
  • investment needs

Owner liability: The more risk involved with the service or product your business provides, the more important owner liability becomes.

Both corporations and LLCs offer business owners some personal liability protection against someone making claims against the business. In fact, this protection is one of the main benefits of an LLC. Conversely, owners of partnerships and sole proprietorships have little personal protection.

Expenses and procedures: Sole proprietorships and partnerships do not require much in the way of fees and documents to start a business. Partnerships do need to create a partnership agreement that specifies who does what in the company.

However, you must file articles of incorporation with your secretary of state's office and pay associated fees to establish a corporation or an LLC. Required fees and forms, such as an LLC operating agreement, vary from state to state.

In addition, the owners of businesses with these two business structures must elect officers to elect to run the company and maintain detailed records of any critical business decisions.

Taxes: The business structure you choose also affects your income tax status. Sole proprietorships, partnerships, and LLCs are "pass-through" tax entities, meaning the taxes on business profits and losses "pass through" to the owners on their personal income taxes. However, these owners must file taxes on all net profits from their business, even if they take no money out of the company during the tax year.

Unlike the "pass-through" structures, corporations are considered separate tax entities. These business owners pay taxes only on the profits they actually take from the business in the form of salaries, dividends, or bonuses. Also, the corporation pays taxes at a lower tax rate than some individuals do.

Investment needs: If your business relies on investors, then a corporation may be the right business structure. Structuring as a corporation allows a company to sell shares of ownership through stock offerings. The previous business structures cannot offer stock.

FAQs About Business Structures

  • What about LLC vs. sole proprietorship?

    Deciding between an LLC and a sole proprietorship is a difficult choice when it comes to legal structure. Many entrepreneurs launch their businesses as sole proprietorships because they are easy and inexpensive to set up and maintain. All profits and losses "pass through" to the owner's personal tax return, and the owner does not need to pay business taxes.

    However, a sole proprietorship is not considered a separate legal entity. Therefore, the owner has unlimited liability protection and can be held personally liable for the obligations of the business.

    As their businesses grow, many sole proprietors restructure their businesses as LLCs, which offer the pass-through tax advantage and limited liability protection.

  • Is a business plan essential?

    A well-thought-out business plan serves as a guide for launching and managing your business and choosing its legal structure. When you go through the steps of how to write a business plan, you'll be able to see more clearly what legal structure you'll need for your endeavor.

    Traditional business plans use a standard structure and offer details on each aspect of the business. A lean startup business plan uses the same structure but summarizes the key elements.

    Depending on your type of business and the structure you choose, you may need to apply for a business registration number. You will use this number to file taxes, open up a bank account, and conduct other official business.

A legal structure is an organizational framework for how a business entity operates. Also called a business structure, a business form, or a business ownership structure, the proper legal structure depends on the size and type of your business and your business goals.

Typical business legal structures include sole proprietorships, limited liability companies (LLCs), partnerships (such as LLPs), and corporations.

Different legal structures come with distinct advantages and disadvantages. In most cases, the criteria you will evaluate to select the right format involve the following:

  • owner liability
  • expenses and procedures needed to create and run the business structure
  • how the business will be taxed
  • investment needs

Owner liability: The more risk involved with the service or product your business provides, the more important owner liability becomes.

Both corporations and LLCs offer business owners some personal liability protection against someone making claims against the business. In fact, this protection is one of the main benefits of an LLC. Conversely, owners of partnerships and sole proprietorships have little personal protection.

Expenses and procedures: Sole proprietorships and partnerships do not require much in the way of fees and documents to start a business. Partnerships do need to create a partnership agreement that specifies who does what in the company.

However, you must file articles of incorporation with your secretary of state's office and pay associated fees to establish a corporation or an LLC. Required fees and forms, such as an LLC operating agreement, vary from state to state.

In addition, the owners of businesses with these two business structures must elect officers to elect to run the company and maintain detailed records of any critical business decisions.

Taxes: The business structure you choose also affects your income tax status. Sole proprietorships, partnerships, and LLCs are "pass-through" tax entities, meaning the taxes on business profits and losses "pass through" to the owners on their personal income taxes. However, these owners must file taxes on all net profits from their business, even if they take no money out of the company during the tax year.

Unlike the "pass-through" structures, corporations are considered separate tax entities. These business owners pay taxes only on the profits they actually take from the business in the form of salaries, dividends, or bonuses. Also, the corporation pays taxes at a lower tax rate than some individuals do.

Investment needs: If your business relies on investors, then a corporation may be the right business structure. Structuring as a corporation allows a company to sell shares of ownership through stock offerings. The previous business structures cannot offer stock.

FAQs About Business Structures

  • What about LLC vs. sole proprietorship?

    Deciding between an LLC and a sole proprietorship is a difficult choice when it comes to legal structure. Many entrepreneurs launch their businesses as sole proprietorships because they are easy and inexpensive to set up and maintain. All profits and losses "pass through" to the owner's personal tax return, and the owner does not need to pay business taxes.

    However, a sole proprietorship is not considered a separate legal entity. Therefore, the owner has unlimited liability protection and can be held personally liable for the obligations of the business.

    As their businesses grow, many sole proprietors restructure their businesses as LLCs, which offer the pass-through tax advantage and limited liability protection.

  • Is a business plan essential?

    A well-thought-out business plan serves as a guide for launching and managing your business and choosing its legal structure. When you go through the steps of how to write a business plan, you'll be able to see more clearly what legal structure you'll need for your endeavor.

    Traditional business plans use a standard structure and offer details on each aspect of the business. A lean startup business plan uses the same structure but summarizes the key elements.

    Depending on your type of business and the structure you choose, you may need to apply for a business registration number. You will use this number to file taxes, open up a bank account, and conduct other official business.