Types of Organizational Business Structures: A Complete Guide
Choosing a business structure is one of the most significant considerations when setting up a company. A business structure legally represents a firm’s organization, stating the company’s owners and how earnings are distributed. According to Daner (2019), the business structure influences various factors, including day-to-day operations, required documentation, the capacity to raise capital, the amount of taxes to be paid, and the risk of personal liability. Therefore, a company should select a business structure that properly balances legal safeguards and benefits (Stowers, 2023). The most prevalent types of businesses include a sole proprietorship, partnership, corporation, and Limited Liability Company (LLC). This paper will analyze the corporate finance strategies of these company structures, their benefits and drawbacks, and how they differ in taxation.
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Sole Proprietorship
A sole proprietorship is a business that is not independent of its owner, and the proprietor’s earnings and losses are subject to taxation in individual tax returns. In a sole proprietorship, an individual controls and manages the company (Corelli, 2018). Since it is the simplest to set up and manage, it is among the most prevalent business forms. Sole proprietorships do not create a distinct company entity; hence the owner may be held personally accountable for the company’s debts and obligations. Raising funds can also be challenging since one cannot sell company stock, and financial institutions are unwilling to lend to sole proprietorships. Sole proprietorships are ideal for low-risk firms and entrepreneurs wishing to test their business ideas before establishing more formal entities.
In addition, the company’s revenues and expenses are reported in the proprietor’s tax return. Since the business is not recognized as an independent legal entity from its proprietor, filing separate income tax forms is unnecessary. The proprietor must submit Form 1040, which must contain Schedules C and SE for self-employment tax (Jones, 2019). The sole proprietorship structure has several advantages, including complete control, ease of establishment, simplified tax filing, and privacy owing to less public disclosure (Jones, 2019). On the other hand, certain drawbacks include personal liability for lawsuits, limited opportunities for raising capital, and a more significant tax burden.
Partnership
A partnership is one of the simplest organizational forms for multi-owner businesses or professional groups, which enables proprietors to test a concept before forming a more formal entity. Limited partnerships (LP) and limited liability partnerships (LLP) are the two most prevalent types of partnerships (Corelli, 2018). Limited partnerships possess a single principal partner with unlimited liability, while all other partners share restricted liability. The partners with restricted liability also exhibit little oversight over the business, as stipulated in the partnership contract. Earnings are reflected in individual tax returns, and the primary partner is liable for self-employment taxes. Limited liability partnerships resemble limited partnerships except that every partner has restricted liability. An LLP shields each member from debts owed to the business; they are not liable for the activities of the other members.
The earnings and losses of the company are transferred to the members when filing taxes, and everyone is obliged to submit the details on Form 1065 with their tax returns. In addition, partners must pay self-employment tax based on their portion of the business’s profits. Schedule K-1, which tracks profits and losses, should be included with Form 1065 (Jones, 2019). A partnership structure has several advantages, including simplicity to set up alongside minimal documentation, fewer tax forms, ease of acquiring funds, and pooled expertise. On the negative side, the partners are personally liable for the company’s financial obligations and responsibilities, and their assets can be liquidated to cover the company’s debts. Disputes among partners could also arise, slowing down the business’s operations. Finally, partnerships have a finite lifespan, possibly caused by partner withdrawal or death (Jones, 2019).
Corporation
A corporation is a form of business structure that provides the company an autonomous legal status from its proprietors. It is more complicated and costly since its proprietors must comply with different tax laws, paperwork, and regulations (Corelli, 2018). Most corporations engage lawyers to manage the entire registration process while ensuring the business conforms with the state statutes in the jurisdiction wherein it is established. When an institution wants to go public by selling common stock to the general public, it must first register as a corporation. Corporations must pay state and federal taxes, while stockholders must report dividend distributions when submitting their income taxes.
Liability protection is one of the benefits of corporations. Because owners are not liable for a corporation’s debts, their assets are protected. As an independent entity, a company can bring and face lawsuits, but its owners are not accountable for such litigation (Jones, 2019). Furthermore, business continuity is ensured. Corporations establish administration on the proportion of stock held, allowing the business to continue operating regardless of whether shareholders leave or sell their shares. This feature gives greater freedom in transferring ownership. Corporations may raise capital by issuing stock and providing shares as incentives for workers. This aspect could assist the company in developing and sustaining it in moments of crisis. Tax exemptions are an added benefit. Even though proprietors pay double taxes on profits, corporations can exclude certain employee benefits and other associated costs. On the adverse side, a corporation is bound to additional demands, including meetings, voting, and board appointing, and is more costly to establish than other business structures (Jones, 2019).
Limited Liability Company (LLC)
A limited liability company (LLC) is a business structure that integrates features of partnerships and corporations. It protects business owners’ liability while minimizing tax and business responsibilities (Corelli, 2018). The business’s revenues and losses are transferred to the owners, and each owner must include a portion of the profits or losses on their income tax filings. Furthermore, a limited liability company has no restriction on the number of shareholders. Jones (2019) states that an advantage of the LLC structure is limited liability. Since an LLC is a separate legal entity, proprietors are not individually liable for the business’s debts or lawsuits. Pass-through taxation is another benefit. Instead of paying corporation taxes, the business’s revenues and expenses are transferred to the members’ tax returns, and the profits are taxed individually. Since the owners are regarded as self-employed, they are eligible for the self-employment tax credit.
Another benefit is increased shareholder participation. An LLC can have infinite shareholders who can actively participate in the firm’s operations. This feature allows for more flexibility in management, unlike a corporation with an elected board of directors to supervise policies and officials to run day-to-day operations (Jones, 2019). Furthermore, the structure exhibits profit distribution flexibility. Unlike a corporation, an LLC can choose how to distribute its profits among its stockholders. On the other hand, one drawback of the structure is that forming an LLC is costly since it must register with the jurisdiction where it wishes to conduct business (Jones, 2019). In addition, the organization may require the services of an accountant and a lawyer to guarantee that taxes and other regulatory demands are met.
Conclusion
The type of business structure that a company chooses influences various factors, such as how much tax to be paid, the company’s capacity to raise capital, the paperwork to be submitted, and the risk of personal liability. As a result, before deciding on an organizational structure, entrepreneurs should analyze their objectives and goals, in addition to the distinctive features of each business structure.
References
Corelli, A. (2018). Analytical corporate finance. Springer.
Daner, M. (2019, March 30). Atascadero Attorney at Daner Law Firm Announces Services to Help Business Owners Decide on The Best Business Structure. PR Newswire. Retrieved May 13, 2023, from https://www.prweb.com/releases/atascadero_attorney_at_daner_law_firm_announces_services_to_help_business_owners_decide_on_the_best_business_structure/prweb16206062.htm
Jones, D. (2019). Business Entity Organization Forms for the Entrepreneur: An Educational Insight. Practical Tax Strategies, 103(2), 1.
Stowers J. (2023). How to Choose the Best Legal Structure for Your Business. Business News Daily. Retrieved May 13, 2023, from https://www.businessnewsdaily.com/8163-choose-legal-business-structure.html