So, you’re ready to become an entrepreneur – you have an idea or a product in mind, maybe even a business plan or website, and you’re ready to make things official and actually register your business… but should you create an LLC? A corporation? An “s-corp,” whatever that is?

Below, I’m going to try to help you determine the best business structure for your new small business or startup. But before I can start making recommendations, I think we need a basic primer on the different types of business structures, how they work, and how they are taxed.

Disclaimer: I’m not a lawyer or an accountant and this is NOT legal, tax, or financial advice. Just information from a fellow entrepreneur with over 20 years of experience.

Business Structures Defined

In this article we’re going to cover the most popular business structures:

  • Sole Proprietorship
  • General Partnership
  • Limited Liability Company
  • S-Corporation
  • C-Corporation

Sole Proprietorship

You’ve probably heard of a sole proprietor or sole proprietorship – that’s the most basic kind of business entity. That’s you, right now. There’s nothing you need to DO to be a sole proprietorship – you already are one. If you drive for Uber or build someone a website or a farmhouse table on the weekends, you have to report that income to the IRS as self-employment income. Sole proprietorship revenue and expenses are reported on a Schedule C or C-EZ and the net profit flows through to your personal 1040 as self-employment income. I know that sounds kind of complicated but it’s really pretty easy, even free tax software like FreeTaxUSA.com can handle it.

Although you don’t have to do anything to register a sole proprietorship with the IRS, you may want to obtain an free EIN or Tax ID number so you don’t have to give your social security number out to vendors and/or clients. Visit the IRS website to register an EIN online. You also may have to register a DBA (doing business as) or obtain a business license from your local city or county. Check with your city/county licensing and permitting office to be sure.

General Partnership

A general partnership is very similar to a sole proprietorship but with more than one owner. You have to register as a general partnership, file a partnership agreement, and do most of the work that you would have to do with a multi-member LLC but do not get any liability protection. I have owned a general partnership and do NOT recommend it. For very little extra effort and cost you can form an LLC.

Partnerships file a tax return to report business revenue and expenses, but like a sole-proprietorship, the net profits flow through to your personal tax return, using a Schedule K-1.

Limited Liability Company (LLC)

A limited liability company or LLC is a separate legal entity that you establish through your state’s Secretary of State (or even a different state, if you prefer). But a single-member LLC works VERY similarly to a sole-proprietorship as far as the taxes go… it still files a Schedule C and profits still flow right through to your personal return as self-employment income. And a multi-member LLC is taxed very similarly to a general partnership.

There’s usually a minimal annual registration fee, and some states like California charge additional taxes and fees for LLCs and C-corps.

So what’s the benefit of having an LLC over a sole proprietorship or general partnership? Since they are effectively taxed the same, there are no tax benefits to having an LLC over a sole proprietorship or a partnership and it may even cost a little more. The main reason people form LLCs is to avoid personal liability for the DEBTS that the business incurs. But as a brand new limited liability company with no credit history and no revenues, your LLC wouldn’t be able to take on any debt. To get a credit card or line of credit with a vendor or a bank, you would most certainly be required to sign a personal guarantee of the debt. We STILL have some credit cards that report to my personal credit, even 20 years later.

But an LLC protects you if you get sued, too, right? Well, to an extent. Having an LLC will protect owners from personal liability for wrongdoing committed by the co-owners or employees of an LLC during the course of business. If an LLC is found liable for the negligence or wrongdoing of its owner or employee, the company’s money or property can be taken to satisfy a judgment. But the LLC’s other owners would not be personally liable for that debt. The owner or employee who committed the act might also be personally liable for his or her actions but a co-owner of the LLC who was not involved in the act or wrongdoing would not be. And whether you have an LLC or not, you should absolutely get business liability insurance, which is a topic for another video altogether.

Bottom line, an LLC doesn’t provide much more protection than just having a sole proprietorship unless you have business partners or employees. That said, there are some good reasons to form an LLC early on especially if you’re in a state where it is very affordable to do so. In my state, it only costs $100 to register a new LLC and $50 a year to renew, and can all be done online. Having an LLC makes it easier in the future should you decide you want your company taxed as an S-corp. It also admittedly just looks more professional than doing business under your personal name or a DBA.

The downsides of the LLC business structure are that you can only have a maximum of 100 members, owners, or investors, so it isn’t used very often for startups that are planning to raise venture capital or eventually go public.

S-Corporation

You’ve probably heard about an S-corporation… they get recommended a LOT online.

An S-corporation is not actually a business entity in itself, but rather an election with the IRS on how you would like to be taxed. You can elect for your LLC to be taxed as an S corporation which gives you certain benefits but also requires additional reporting and overhead which costs money.

Basically, if you elect to be taxed as an S-corporation you have to put yourself on W2 payroll as an employee of your business and pay yourself a reasonable salary, taking out all federal and state income taxes and medicare and social security taxes and filing them with the IRS and your state. You’ll have to run regular payroll whether you have any other employees or not, or pay a payroll provider like Gusto to do it for you.

The benefit is that any net profits above that reasonable salary would not be subjected to self-employment taxes, which could save you close to 15% on net profits above your salary. The revenue and expenses of the S-corporation are reported through form 1120S and the net profits flow through to the owners just like with a regular LLC.

C Corporation

The C-corporation is the most complicated of these business structures and one that most small businesses would never want to have. C-corporations are completely separate entities and have to file and pay taxes – the taxes do not pass through to the owners. Because of this, you often hear about “double taxation” with C-corporations. There are some tax advantages to a c-corporation but they usually only come into play in much larger companies. The additional filing requirements, taxes, and complexity of managing a c-corporation usually don’t make sense for smaller businesses to get any benefit from it.

The exception is if you know you are going to be seeking venture capital or other investments in your company or if you plan to eventually go public. Obviously, few small businesses will raise venture capital or go public, but if you know that’s the path you are going to take, then you should consider incorporating as a c-corp.

A C-corporation lets you manage multiple classes of stock like common and preferred. This is necessary if you plan on raising multiple funding rounds or offering stock options to employees.

You can also make an election to have an LLC taxed as a c-corporation, but that’s rarely used because it has the downsides of double taxation without any of the benefits of a c-corporation like having multiple classes of stock.

So what is best for your small business?

So what business structure is best for your small business? Well, it depends. Personally, I have owned sole proprietorships, g