What is the best legal structure for my business?
LEGAL
One of the most important initial decisions we must make when starting a business is the type of legal structure. There are several possible alternatives, each with its advantages and disadvantages. The unique characteristics associated with each structure can affect a company's legal liability, taxes, and other operational factors. We must choose the one that best suits our particular situation.
What is the best Legal Structure for my Business?
One of the most important initial decisions we must make when starting a business is what legal form we want to give it. There are several possible alternatives, each of which has its advantages and disadvantages. The unique characteristics associated with each structure can affect a company's legal liability, taxes, and other operational factors. We must choose the one that best suits our particular situation. In this article we are going to explore the most relevant options.
1.-Unipersonal Company or “Sole Proprietorship”
A sole proprietorship is a type of business entity in which an unincorporated business is owned and operated by one natural person. Sole proprietorships are also called sole trading companies, sole proprietorships or sole proprietorships.
In this business structure, the sole owner maintains full control of the company without legal separation between the company and his person. Therefore, the owner is responsible for the taxes and obligations of the company and receives all profits generated by it.
Advantages
It does not require business owners to obtain an employee identification number (EIN) from the IRS.
The establishment process is very simple
It is what is called a “pass through” type entity, meaning that the net income must be declared by the owner on his or her personal tax return.
Disadvantages
The owners have no limitation of liability and are therefore responsible for all debts and losses.
The owner's personal assets are not separate from the company's assets.
When are they recommended?
It may be recommended for independent workers and contractors who do not have employees.
2.-Collective company or “General Partnership”
A general partnership is a type of business in which two or more people, also known as general partners, enter into an agreement to jointly establish and run a business, sharing the responsibilities of its management.
Partnerships operate for profit and all general partners involved are responsible for the business. Additionally, general partners have unlimited legal liability for the organization.
Advantages
Easy to set up.
May offer tax benefits; Partnerships do not pay income tax.
Partnerships can be easily dissolved.
Disadvantages
There is no liability protection for the partners' personal assets.
Partners are responsible for the actions of other partners.
When are they recommended?
Partnerships are best applied when the participants work in the same industry, or when they want to collaborate closely on a business. For example: spouses or partners doing business together, Law Firms and others.
3.-Limited Partnership
Limited partnerships are business entities formed by two or more people, including one or more general partners and one or more limited partners. In this structure, the general partner(s) have unlimited personal liability, while the liability of the limited partner(s) is limited to their investment in the company. These companies operate in accordance with an agreement drawn up between the partners to regulate their operation.
Advantages
Limited partners have limited liability for losses.
Labor responsibility is shared between the partners.
Disadvantages
Limited partners have less power in making business decisions.
General partners are personally responsible for the debts of the company
A breach of the agreement may put the company at risk of dissolution.
When are they recommended?
It is recommended for Mutual Funds, Venture Capital Funds and other similar activities in the financial sector.
4.-Limited Liability Partnership (LLP)
Limited liability companies are partnerships of two or more people, each of whom has protection for business assets in the event of another partner's negligence.
They offer greater flexibility in the operational management of the company, since the operation of the company and the distribution of profits are determined between the partners in the social contract.
Advantages
All partners are protected from the negligence and faults of other partners.
LLPs offer flexibility in business management structure.
Disadvantages
It may involve additional incorporation costs.
They are only available in 40 states.
States that allow them limit their use to specific professions.
When are they recommended?
They usually include people who work in professional services firms, such as: lawyers who work in law firms, accountants who work in accounting firms for financial advisory companies, doctors or dentists in offices, and the like.
5.-Corporación C o “C Corporation”
C corporations are a legal structure where the entity is owned by its shareholders. C corporations are taxed separately from their owners. This means that profits generated by a C corporation are taxed twice: at the entity level as business income and at the shareholder level when the shareholder earns the profits, either as capital gains or dividend distributions.
Once formed, a C corporation is an independent entity from its owners, offering them the protection of limited liability. This type of structure is often attractive to some investors because they have fewer restrictions on accepting venture capital funding.
Advantages
Shareholders are not personally responsible for the debts, liabilities and obligations of the company.
They allow an unlimited number of shareholders.
They can accept investments from individuals as well as from partnerships and other corporations.
Disadvantages
C-corps are taxed twice, both at the corporate level and at the level of each shareholder.
Deductions for C-corps are limited to the corporation's return. Losses cannot be deducted on shareholders' individual tax returns.
The establishment process is more complex and may require legal advice.
When are they recommended?
They are commonly used by large business structures or those seeking important investors. The fact of double taxation, business and personal, normally does not make them attractive to small business owners. They may be the right choice for publicly traded companies, small businesses looking to expand their operations, companies with more than 100 shareholders, and others.
6.-Limited Liability Company or “Limited Liability Company, LLC”
Limited liability companies (LLCs) are a very popular form of business entity. They represent the majority of partnerships (71.7%) according to IRS data. They can be owned and operated by a single or multiple members, making them an excellent option for individual entrepreneurs looking to start their business.
An LLC is a business entity in which the owner's personal assets are protected from legal claims directed at the company. LLCs offer the best of both worlds, providing the protection of limited liability and the flexibility of partnership business structures. LLCs can include unlimited individual members. They differ from limited partnerships in that liability protection extends to all partners of the entity, including those with administrative authority.
Limited liability companies (LLCs) are what are called "Pass-Through Entities". Or “Pass through Entities”, which means that the company does not pay income taxes. It is the individual owners or partners who pay taxes on the income received.
Advantages
They protect the owner's assets from legal claims.
LLCs have flexible tax options and can be taxed as C or S corporations.
They have very few restrictions regarding ownership
Fewer formalities: By forming an LLC, you will not have to comply with the strict requirements of directors and shareholders meetings and other formalities typical of a corporation.
Disadvantages
They may be subject to termination for failure to comply with requirements established by state law.
When are they recommended?
LLCs may be the ideal option for those who want to pay lower tax rates while protecting their personal assets. Many businesses take advantage of the tax benefits and liability protection offered by an LLC structure, especially during their startup and early years.
7.Special denominations for Corporations
It is important to discuss certain special denominations that corporations can display and that give them certain particular characteristics. S corporations (S Corp.) and B corporations (B Corp.), although both include the word "corp" in their names, are not exactly business structures. The S corporation is a tax designation and the B corporation is a business certification.
Many business owners decide to add the S corporation designation or B corporation certification to their business when forming their corporation.
Below is a brief summary of each of them, along with their advantages and disadvantages to help you decide which is the best option for your business.
S Corporation
S corporations, or S-Corps, are business entities that choose to transfer corporate profits, losses, credits, and deductions to their shareholders' tax returns. In this way, these "pass-through entities" do not pay federal income taxes; only its shareholders do. This avoids double taxation on corporate income. Shareholders are solely responsible for paying federal income taxes on their share of the S-corp's income, and at their individual income tax rates.
S corporations are currently gaining popularity, accounting for 76.6% of all U.S. corporations, according to data from the U.S. Bureau of Economic Analysis.
The tax implications of this business structure make it an attractive option for small businesses.
Advantages
Profits, losses, deductions and credits pass through to your shareholders' tax returns, rather than being taxed at the entity level.
S corporations offer limited liability protection.
Shareholders' non-salary income is not subject to self-employment tax.
Disadvantages
It has limitations on the number and type of shareholders, which may pose certain inconveniences when raising share capital.
They must withhold and pay payroll taxes on shareholders' salaries.
Tax processes for S corporations involve sending forms to shareholders and filing payroll tax returns.
When are they recommended?
S corporations have restrictions on the number of shareholders they can have, which can be advantageous for small businesses that want to limit the number of owners in their organization.
B Corporation or “B Corp.”
A benefit corporation, also known as a B corporation, is a type of for-profit company that has received certification from B Lab, a nonprofit organization that evaluates a company's social and environmental standards. To obtain certification, B corporations must maintain high standards and a commitment to corporate social responsibility, through verified performance, with full transparency and accountability.
Entrepreneurs may choose to register their business as a B corporation to appeal to consumers, as consumers often choose to support brands that espouse social and environmental values.
Advantages
B-corp certification can be a sign of trust and transparency to potential clients.
Certification grants companies access to resources and support from the global B-corp community.
B-corp status can increase the likelihood of financing by attracting investors interested in social or environmental impact.
Disadvantages
B-corp certification involves fees that depend on the company's sales volume and can range from $1,000 to $50,000 annually.
The entity must comply with B-corp standards, which can be difficult for organizations with limited resources.
Becoming a B-corp may require changes to a company's legal structure in some jurisdictions.
When are they recommended?
B-corps can be ideal business structures for small or large companies committed to social and environmental responsibility. Any type of business structure, from a sole proprietorship to a partnership or C-corp, can apply for B-corp certification.
8.- Non-Profit Organization or “Nonprofit”
A nonprofit business entity is a variant of a traditional C corporation that does not operate for profit. These corporations operate to benefit the public and often maintain missions that support social, scientific, educational, religious, or charitable causes. They must comply with established standards to guarantee their political impartiality. By following these guidelines they can obtain benefits such as liability protection and the ability to apply for tax exemption. A large number of them are located in the social assistance and health sectors.
Disadvantages
Nonprofit organizations with tax-exempt status must file annual disclosure statements about their finances.
They must comply with strict regulations that govern their organization and administration.
The business structure of nonprofit organizations involves excessive paperwork and strict reporting deadlines.
When are they recommended?
Nonprofit organizations are founded to serve a charitable cause and therefore reinvest their income to fulfill their mission, rather than distributing it to shareholders.
A nonprofit business structure may be ideal for entities that operate with the purpose of supporting charitable causes.
What is the most convenient Legal Structure for you?
When defining the most convenient legal structure, we must take into account various factors:
The level of civil liability protection your company requires
Evaluate your small business needs to identify the level of liability protection you need. Consider how the different structures available to your business address liability protection for owners.
The tax implications of different business structures
Each of the structures described in this article has its own tax requirements. When choosing a structure for your small business, consider how its tax requirements would affect your tax obligations. If you have questions, it may be prudent to consult with a business advisor, accountant or lawyer.
The level of control you want over your company
As a business owner, your control over business decisions may depend on the type of structure you choose. For example, partnerships require multiple partners to share decision-making responsibility, while sole proprietors operate individually and retain full control over business decisions.
The way in which you plan to capture Capital
Some business structures, such as corporations, are attractive to investors because they can issue shares. On the other hand, other structures, such as sole proprietorships and partnerships, have limited access to external investments.
The costs and complexities associated with each structure
Registration fees, paperwork, and regulatory compliance can be a problem for small business owners. It is important to evaluate the complexities and costs associated with each structure and consider how these factors would impact your business processes.
How does each structure align with your long-term business goals?
Your company's long-term goals may be more or less achievable depending on the structure you choose. For example, small businesses that plan to grow quickly can benefit from a structure that allows them to more easily raise a larger amount of capital, such as a corporation.
It is important to try to choose a legal structure that is aligned with the long-term goals of your small business.
Final Comments
Choosing a business structure for your organization is a crucial decision that can influence your future operations, your legal responsibilities, and your overall success.
It is vitally important to consider the different aspects of each structure to determine the best option for your organization. Factors such as legal liability, tax implications, management structures and other administrative requirements may vary between structures and may influence the future growth of your business.
We must choose a business structure that fits the current needs and long-term objectives of the organization, in order to guarantee the current and future success of our business.