How to Choose a Business Structure

As you take the leap into self-employment, there are plenty of thrilling decisions to make, from setting your prices to marketing your brand. But let's face it, choosing the right business structure probably isn't one of them.

This choice isn't just about paperwork; your business structure influences how you're taxed and the extent of your personal liability if something goes south. But with five different types of business structures to choose from, how do you know which is right for you? 

This guide breaks down everything you need to know to make an informed decision that protects your assets and optimizes your tax situation.

Quick Answer: Which Business Structure Should You Choose?

Most freelancers and small business owners should choose:

• Sole Proprietorship: Simplest option, no liability protection, no setup costs

• LLC: Best balance of protection and simplicity for most entrepreneurs

• S Corporation: Ideal for high earners seeking tax savings

• C Corporation: For businesses planning to raise investor funding

30-Second Decision Framework

• Just starting/testing your business idea? → Sole Proprietorship

• Have personal assets to protect? → LLC

• Making significant income and want tax savings? → LLC with S-Corp election

• Planning to raise investor funding? → C Corporation

What is a Business Structure?

A business structure, sometimes referred to as a business entity, is the legal framework that defines how your business operates. Your choice affects two critical areas:

1. Tax obligations: How much you pay and when

2. Personal liability: Whether your personal assets are at risk

5 Common Types of Business Structures

Most small business owners choose one of these five business structures: sole proprietorship, partnership, LLC, S Corporation, or C Corporation. Let’s take a look at each. 

1. Sole Proprietorship

Typically best for: Freelancers and contract workers just starting out

A sole proprietorship is the simplest business structure you can have. If you do nothing to form a legal business structure, the IRS considers you a sole proprietorship by default. 

Key Facts:

• No paperwork required to start

• No legal distinction between you and your business

• You're personally responsible for all business debts and lawsuits

How to become one: Simply start doing business. No licenses or permits needed unless required for your specific work.

Taxes: As a sole proprietor, you will report your business income and expenses on your personal tax return using Schedule C. You will also need to pay self-employment taxes, which cover Social Security and Medicare. 

Pros:

• Easy and inexpensive to set up

• No need to file a separate tax return

• Complete control over the business

• All profits go to the owner

Cons:

• Unlimited personal liability

• Limited ability to raise capital

• No separation between personal and business assets

2. Partnership

Typically best for: Businesses with 2+ owners who want simple structure

A partnership is where two or more people own a business together. There are two main types:

• Limited Partnership (LP): At least one general partner with personal liability, plus limited partners without liability

• Limited Liability Partnership (LLP): All partners have limited liability protection

How to become one: To register as a partnership, you will need to file a partnership agreement with your state's Secretary of State office.

Taxes: As a partnership, the business income and expenses are reported on a partnership tax return. Each partner will receive a K-1 form that shows their share of the business's income and expenses. They will then report this on their personal tax return.

Pros:

• Personal liability protection for all partners (in an LLP)

• Easy to set up and operate

• Pass-through taxation

Cons:

• Unlimited personal liability for general partners (in an LP)

• Limited ability to raise capital

• Can be difficult to manage if there are many partners

3. Limited Liability Company (LLC)

Typically best for: Freelancers and entrepreneurs with personal assets to protect

An LLC shields your personal assets from business liabilities. If your LLC goes bankrupt or faces a lawsuit, creditors can't come after your house, car, or personal bank accounts.

How to become one: Forming an LLC involves selecting a unique business name and filing articles of organization with your state's Secretary of State office online. You may also wish to get an Employer Identification Number (EIN) for your business, so you don’t have to hand out your Social Security number to clients. 

Taxes: The beauty of an LLC is its flexibility in taxation. By default, the IRS treats all LLCs as a sole proprietor. You report your business income and expenses on your personal tax return using Schedule C. You only have one tax form to file.

Pros:

• Legally protects your personal money

• Only one tax return to file in most cases

• Can include multiple members

• Fairly easy to maintain

Cons:

• More paperwork than sole proprietorships or partnerships

• Must register with the state and pay a fee

• Has the same tax structure as a sole prop, by default

There is also a lesser-known tax status you can choose as an LLC: You can elect to be taxed as an S Corporation. Generally, the income threshold where it makes sense to shift from an LLC that’s taxed as a sole proprietor to an S-Corp varies based on your state and financial situation. Working with a CPA to look at your options could pay off in the long run.

4. S Corporation

Typically best for: High-earning business owners seeking tax advantages

An S Corporation allows you to pay yourself a reasonable salary and classify remaining earnings as distributions, potentially reducing self-employment tax liability. However, this structure requires more complexity and professional assistance.

How to become one: To register as an S Corporation, you will need to file articles of incorporation with your state's Secretary of State office. You will also need to file Form 2553 with the IRS to elect S Corporation status.

Taxes: Business reports on corporate tax return, but profits and losses pass through to shareholders' personal returns. You only pay self-employment taxes on your salary, not distributions.

Pros:

• Personal liability protection

• Pass-through taxation

• Can provide significant tax savings

Cons:

• More expensive to set up and operate 

• Limited ability to raise capital

• More complex management structure

5. C Corporation

Typically best for: Businesses planning to attract external investors

C Corporations provide unlimited growth potential and allow you to issue different classes of stock to raise capital and attract investors. However, they face double taxation on profits.

How to become one: To register as a C Corporation, you will need to file articles of incorporation with your state's Secretary of State office.

Taxes: As a C Corporation, the business income and expenses are reported on a corporate tax return. The profits are taxed at the corporate level, and any dividends paid to shareholders are taxed again on their personal tax returns.

Pros:

• Limited liability for owners

• More access to capital

• No limit on the number of shareholders

Cons:

• Double taxation

• Extensive paperwork and bureaucratic procedures

• High regulatory compliance and administrative costs

Business Structure Comparison

Here's a side-by-side comparison of important features to consider when choosing your business structure. This table focuses on the two biggest factors that will impact your business: how much protection you'll have for your personal assets and how you'll be taxed.

Key Features Overview

How to Choose Your Business Structure: Key Decision Factors

1. Personal Liability Risk

Question: How much personal liability are you willing to accept?

• High risk tolerance: Sole proprietorship or general partnership

• Want asset protection: LLC, S Corporation, or C Corporation

2. Tax Implications

Question: What's your income level and tax situation?

• Starting out/low income: Sole proprietorship for simplicity

• Moderate income with assets: LLC for protection

• High income: Consider S Corporation election for tax savings

• Need investor funding: C Corporation despite double taxation

3. Complexity Tolerance

Question: How much paperwork and maintenance can you handle?

• Want simple: Sole proprietorship

• Moderate complexity okay: LLC

• Can handle complexity: S Corporation or C Corporation

4. Growth and Funding Plans

Question: Do you plan to raise money or bring in partners?

• Solo operation: Sole proprietorship or single-member LLC

• May add partners: LLC or partnership

• Need investor funding: C Corporation

Sole Prop or LLC? Make Tax Time a Breeze with Found

For most solo entrepreneurs and small business owners, the choice comes down to sole proprietorship versus LLC. If you're just starting and want to test your business idea with minimal complexity, sole proprietorship works well. If you have personal assets to protect or want to appear more professional to clients, an LLC provides the best balance of protection and simplicity.

Once you choose a business structure, figuring out how to prepare for taxes becomes the next hurdle for a lot of entrepreneurs. Luckily, Found helps you put your taxes on autopilot. Once you open a Found account, we find and track tax write-offs, estimate your tax bill, auto-generate your Schedule C or 1120/1120-S forms, and more. Try Found today to see for yourself.

The information on this website is not intended to provide, and should not be relied on, for tax advice.