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Business Structure 101 and Entity Registration

Business Structure 101 and Entity Registration

When starting a business, sometimes the thought of forming a legal business structure and going through the process business registration can seem overwhelming. Don’t sweat it- we’ve created this business structure 101 to help walk you through the entire process.

Business registration is the process of registering your business with the relevant federal, state or local agencies to make it a distinct legal entity. The most common forms of business entities are sole proprietorships, partnerships, limited liability partnerships (LLC) and corporations.

Here, we will explore the choices and the process more in depth. Looking to learn more about the basics of starting a business? Check-out our 101 posts on bookkeeping and tax.

Do I Need to Register My Business?

When you decide to start your own business, you have to decide which type of legal entity will work best for your operation. There are benefits and disadvantages to registering your business which you should carefully consider when making this decision.

You do not have to register your business if you plan to:

  • Conduct business as yourself using your legal name
  • Conduct business with one or more partners under a general partnership

If you plan to conduct business as any other type of legal entity than a sole proprietorship or general partnership, you are required by law to register your business with the federal, state and local governments.

Regardless of whether you need to register your business, you may still want to register your business name.

Choosing a Business Name

Once you land on a business name you like that suits your brand and product, you’ll want to protect it by registering with the government so no one else can use the same name. There are four different ways to register your business name, each serving a different purpose. Some may be legally required. You may register the business as:

  • An entity– The name protects you at the state level.
  • A trademark– This protects you at the federal level.
  • Doing Business As (DBA)– DBA doesn’t give legal protection, but it might be legally required in some states.
  • A domain– The name protects your business website address.

Each of these name registrations is legally independent. You will need to decide which ones you need and want to register based on your location and business structure. Most businesses try to use the same name for each kind of registration, but you’re not normally required to.

Business Registration vs Business Incorporation?

Some people may confuse business registration with business incorporation.

Business incorporation is the process of forming a corporate entity.

You can register your business as any legal entity, but you would only incorporate if you want to form a corporation.

How to Choose the Right Business Entity?

There are five main entity types that cover most businesses you know. The key difference between each entity type is the ownership structure (number of people running the business), the degree to which the owner(s) is protected from personal liabilities of any business debts and obligations, or how the business is taxed. 

The business entity you choose for your business will have direct impact on:

  • The size of your business and operations
  • How you report and file taxes
  • Your share of business profits
  • Your degree of ownership and accountability
  • Your legal liability
  • Your options to raise funds

Now let’s take a closer look at each one.

Sole proprietorship

A sole proprietorship is the simplest form of business structure as well as the simplest to set up. The business is owned and operated by a single person (or a married couple). In fact, as soon as you start running a business solo, you’re automatically considered a sole proprietor by the government for legal and tax purposes. The owner of a sole proprietorship can choose to operate alone indefinitely or hire contractors or employees.

In a sole proprietorship, any company assets and liabilities are held in the owner’s name. There is no legal separation between the business owner and the business itself. The owner is liable for any business debts and obligations.

For business taxes, business profits are passed through to the owner’s personal tax returns and filed on Schedule C (Profit or Loss from a Business) on IRS Form 1040.

A sole proprietorship would be a good choice for a low-risk business where the owner would like to test the viability of their business idea before choosing a more formal business structure.

Sole proprietor summary

Pros

  • Easy and affordable to set up with no legal paperwork required (other than local licenses and permits)
  • 100 percent control and ownership
  • Can easily evolve into other entity types as the business grows

Cons

  • Owner is not protected against personal liabilities to company debts and obligations
  • Owner is taxed as an individual, which means giving up a much larger share of profits than being taxed as a corporation
  • More difficult to raise capital or get financing

Best for

  • You want to run your business solo and hit the ground running as soon as possible
  • You desire to run a small operation with no more than a few employees
  • Common examples include mom-and-pop shops, freelancers, one-person consulting agencies or new e-commerce sellers

Partnership

In its simplest form, a partnership structure is nearly identical to a sole proprietorship and is utilized when there are two or more individuals who own and operate the business. 

A partnership should be agreed to by all owners, and those details should be documented in a partnership agreement which addresses the legal, financial, and management responsibilities of the business. A partnership agreement is particularly critical in determining each partner’s share of profits and losses from the business.

There are several variations of a partnership:

General Partnership: Each partner has equal control of the business and each is equally liable for business debts and obligations.

Limited Partnership: At least one partner is a limited partner, who typically only contributes money or assets, with limited or no involvement in the day-to-day operations of the company. Their liability is limited to their initial investments.

Limited Liability Partnership: At least one of the partners is a limited liability partner, which is a limited partner who participates in the day-to-day operations of the company

It’s important that you choose the right type of partnership based on your business goals.

  • Choose general partnership if you and your partners plan on splitting all contributions, profits and losses equally
  • Choose limited partnership or limited liability partnership: if only some of the partners will be running the day-to-day operations and some partners have limited involvement in decision making and limited liability
  • Consider a joint venture If you’re just looking to test out a new idea with other people before committing to a general partnership

For business taxes, profits and losses are passed through to the personal tax returns of each partner. The partnership also needs to file an annual information return – Form 1065.

Partnerships, similar to sole proprietorships, would be a good choice for a low-risk business where the owners would like to test the viability of their business idea before choosing a more formal business structure.

Partnership summary

Pros

  • Easiest and most affordable to set up for business with more than one owner
  • Can easily evolve into other entity types as the business grows

Cons

  • Partners are not protected against personal liabilities to company debts and obligations
  • More difficult to raise capital or get financing

Best for

  • If you and your business partner want to test out a business idea with other potential partners
  • If you and your partners want to run a small operation with up to a few employees
  • Common examples include restaurants, retail shops, professional service practices

Limited Liability Company (LLC)

In its simplest form, a partnership structure is nearly identical to a sole proprietorship and is utilized when there are two or more individuals who own and operate the business. 

An LLC is a hybrid entity that offers the personal liability protection of a corporation with the passthrough taxation of a sole proprietorship / partnership. Owners of an LLC can choose how they’d like to be taxed – whether they’ll report business profits and losses on their personal tax returns, or be taxed as a corporation.

For most small businesses, a LLC offers a good mix of personal liability protection and simplicity. Relative to corporations, LLCs are easier and more affordable to form and maintain. However, it’s important that you choose your partners carefully when starting an LLC – in the event one of the partners leave, you’ll need to dissolve the LLC.

An LLC is the best option if you want a simple solution to protect your personal assets.

LLC summary

Pros

  • Offers personal liability protection without the complexity or cost of a corporation
  • Passthrough taxation – business profits and losses are passed on to the owners’ individual tax returns
  • The easiest way of choosing the S Corporation tax designation

Cons

  • More complex and costly to set-up than a sole proprietorship or partnership
  • You must dissolve the LLC if one of the partners leave

Best for

  • If you want personal liability protection without having to form a corporation
  • If you want to be taxed as an S Corporation without having to form a corporation
  • Common examples include start-ups

Corporation – C Corp

C corporations are the most common form of corporations in the U.S. Unlike in a sole proprietorship or partnership where there’s no legal separate between the business owner and the business itself, a corporation is considered its own legal entity that incurs profits or losses, and is taxed separately from its owners.

C Corp summary

Pros

  • Offers personal liability protection for owners
  • Ability to bring on investors and sell stocks to grow the business
  • Flat tax rate of 21 percent (The Trump Tax Reform)

Cons

  • Complex and expensive to form and maintain
  • The corporation is taxed twice, once as a separate legal entity, then again for each shareholder for their portion of the profits on their personal tax returns 

Best for

  • Your company is expecting significant growth
  • Your company has the knowledge or resources to navigate the complex legal and financial aspects of forming and maintaining a corporation
  • Common examples include large businesses such as retail / restaurant chains

Corporation – S Corp

An S corporation must always start as a C corp, and is more of a tax designation rather than a business entity. Just like a C corp, an S corp is a separate legal entity, and the owners are protected against personal liability. The biggest incentive to become an S corp is for the potential tax savings.

Unlike in a C corp where the business profits and losses are incurred by the corporation and taxed separately from its owners, in an S corp the profits and losses are passed onto its owners personal tax returns. In other words, each owner is taxed based on their share of the business profits or losses.

S Corp summary

Pros

  • Offers personal liability protection for owners
  • Passthrough taxation – business profits and losses are passed on to the owners’ individual tax returns
  • Offers some flexibility for growth – ability to sell stocks and bring on investors

Cons

  • Can only have a maximum of 100 shareholders (must be US citizens or residents)
  • Only allowed one type of stock
  • Can be subject to higher level of monitoring by the IRS due to the major tax benefit
  • The corporation is taxed twice, once as a separate legal entity, then again for each shareholder for their portion of the profits on their personal tax returns 

Best for

  • If your company is expecting some growth, but you’re not trying to be the next Uber
  • If your company has the knowledge or resources to navigate the complex legal and financial aspects of forming and maintaining a corporation
  • Common examples include medium businesses such as local retail / restaurant chains

Choosing the Right Business Structure For You

To choose the right business structure for your situation, start by asking yourself a few questions to better understand your goals and priorities.

  • Do you plan to run your business solo or with partners?
  • How committed are you to this business idea? Are you in it for the long haul?
  • Do you plan to issue stocks and bring on additional investors in the future? 
  • How big do you want your business to grow?
  • Do you need protection against personal liabilities in the business?

How to Register Your Business?

Your location and business entity type will determine the process of registration. Follow the general steps below to complete your registration.

1. Check your eligibility and registration requirements. To register your business as a legal entity other than a sole proprietorship or general partnership, you’ll probably need to register with any state where you plan to do business. Most states require you to register with the Secretary of State’s office, a Business Bureau or a Business Agency. Check your Secretary of State’s website for the application process, fess and requirements.

2. Choose and register your business name. Now the fun part! Once you’ve landed on the perfect name, you will need to decide the level of legal protection that’s right for you. Here’s a recap of the different types of name registration:

  • Entity name protects you at state level
  • Trademark protects you at a federal level
  • Doing Business As (DBA) doesn’t give legal protection, but might be legally required in some states
  • Domain name protects your business website address

For most small businesses, it’s always a good idea to have a Doing Business As name even if you’re not legally required to have one. You’ll need it to open a business bank account among other benefits.

3. Find a registered agent. If you’re registering as an LLC, corporation, partnership or nonprofit corporation, you’ll need a registered agent in your state before you file. A registered agent is a person or company who accepts legal papers and documents on your business’s behalf. Many business owners opt to use a registered agent service or a full-packaged business registration service.

4. Register with state agencies. Follow the instructions from your Secretary of State’s website to complete registration. Some states allow you to register online, while some others require paper documents delivered in person or through the mail.

5. Get a federal tax ID. The federal tax ID, also known as your Employer Identification Number (EIN),is like a personal social security number, but for your business. You need an EIN to pay federal taxes, hire employees, open a business bank account and apply for a business license or permits.

6. Apply for licenses and permits. If your business is an LLC, corporation, partnership or nonprofit corporation, you might need to apply for licenses and permits from the county or city. Check your Secretary of State’s website for more information. Depending on the type of business, you may also need to apply for federal licenses and permits.

About Zoey Wen

Content contributor and website admin @ Exper.

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