Knowing the different types of business ownership is essential if you are someone looking to start your own business right now.
Because of this, you need to be very familiar with the different business structures out there.
The type of business you choose will determine many things, including filing taxes, legal liabilities, and company ownership.
In this post, we will cover the five business types of business covered by the IRS. We will also discuss each kind of company and help you determine which one is right for you.
What Are the Five Different Types of Businesses?
In a nutshell, when you start a business
, you can choose from five main types of business
Find the best types of legal structure for small businesses
- Sole Proprietorship
Advantages and Disadvantages of Business Ownership Types
Below is a quick definition of each type of business ownership and some essential concepts to know.
Sole Proprietorships are the most common type of business in the U.S., as they are the simplest to operate.
A sole proprietorship is simply an unincorporated business owned and run by one person. The company is not distinct from the owner, meaning the owner can be personally liable for any debts or lawsuits caused by the business.
While sole proprietorships are great for those who want complete control of their business, it does make it harder to fund the company as you are less likely to be able to find investors or be approved for loans.
Sole proprietorship pros and cons
There are several pros to becoming a business owner in this structure, including:
- You have complete control and decision-making power over the business.
- No additional legal or administrative costs are associated with setting up or running the business.
- You can start and run the business with little or no financial investment.
However, there are also some drawbacks to consider. These include:
- There is personal liability for all debts and liabilities of the business.
- If you decide to sell or close down the company, there is no continuity if it dissolves along with you.
- There is limited potential for growth, as the business is limited by your own
A partnership is very similar to a sole proprietorship, except that there are multiple owners instead of one. Most commonly used by married couples who want to start their own business.
Keep in mind that a partnership can have more than two owners.
Each owner has equal control of the business, and liability is similar to that of a sole proprietorship.
Each partner is equally liable, meaning that if one partner takes out a loan, both partners are responsible for that loan. Partnership taxes are shared and reported by both partners.
Partnership pros and cons
There are both advantages and disadvantages to partnerships.
Some of the most attractive pros of this business ownership are
- Greater financial resources
- Expertise and workforce
- Helps businesses expand their reach
- Build important relationships
However, partnerships have problems and cons, such as
- It can be challenging to manage, with disagreements over decision-making, communication issues, and power struggles often arising between partners.
- Partnerships can be a liability if one partner is not financially responsible or the business faces legal trouble.
A corporation, sometimes called a C corporation, is a business that is legally separate from its owners.
The most significant difference between a corporation and a sole proprietorship is that the owners are not personally liable for the debts or obligations of the corporation. Corporations are also taxed separately from their owners, often twice (once on profits and again when shareholders receive dividends).
The owners being separate makes this company much longer-lasting because if the owner leaves the company (or becomes ill or deceased), the company can carry on, unlike the previous types of business ownership.
Corporation pros and cons
There are many pros to incorporating your business, including
- Limited liability protection for shareholders
- Easier access to capital
- Increased credibility with customers and suppliers
However, this business entity has also some disadvantages to consider, including
- More expensive and time-consuming to set up and maintain
- Double taxation of profits (corporate tax followed by dividend tax)
- Increased government regulation and scrutiny
S Corporations are a particular type of corporation created to avoid the double taxation that corporations face explained above.
These operate like C Corporations, except that profits and losses can be passed directly to the owner's personal income taxes, so the owners do not have to pay taxes on gains and dividends.
S Corporations have stricter regulations that you must meet to create one, including stipulations such as having no more than 100 shareholders or forbidding anyone but a U.S. citizen from being a shareholder.
S Corporation pros and cons
There are several key advantages of S Corporations that business owners should be aware of
- S Corporations offer greater flexibility when distributing profits and losses among shareholders. This can be a significant advantage for businesses with multiple shareholders.
- This business structure is not subject to corporate income tax. This can result in significant tax savings for the business.
- An S Corporation offers shareholders limited liability protection. This means that shareholders are not personally liable for the debts and liabilities of the corporation, so the personal assets are protected.
Limited Liability Company
A Limited Liability Company (LLC) is a mix between partnerships and corporations.
Like Corporations, owners are not personally liable for debts or obligations created by the company. Like partnerships, the profits and losses pass through to the owner's taxes, so there is no double taxation.
While this may seem like the best of both worlds, keep in mind this type of business has various regulations and requirements in each state. Some states impose special franchise taxes, while others may only allow LLCs under certain conditions.
Limited Liability Company pros and cons
This business entity offers some of the benefits of a corporation while avoiding some drawbacks.
- Limited liability protection for the owners
- Flexible management structure
- Pass-through taxation
On the other hand, some disadvantages of a Limited Liability Company are
Compare the benefits of a sole proprietorship vs. a partnership
- More expensive to set up than a sole proprietorship or partnership
- It May be subject to more stringent regulations than a sole proprietorship or partnership
- Limited life span (the LLC dissolves when one of the owners dies or leaves the business)
Types of Business at a Glance
Grasping these five types of business differences can be a bit complicated. But here is a quick chart you can use to remember the different types of businesses
|Types of Business Ownership
- Owned by one person
- The owner is personally liable for everything about the business
- The IRS can tax the owner's taxes through the gains and losses.
- The company closes when the owner quits or dies
- Owned by more than one person
- All owners are equally liable for all aspects of the business
- The IRS tax the profits through all owner's personal taxes
- The company might stop when any owner quits or dies
- Are owned by shareholders or a board of directors
- Owners are not personally liable for actions of the business
- They are taxed twice, once for profits, then for dividends paid to shareholders
- The company can continue if the owner quits or dies
- Owned by shareholders or a board of directors
- Owners are not personally liable for the debts and obligations of the business
- They are only taxed once through the owner's taxes
|Limited Liability Company
- Owned by one person or multiple people
- Owners are not personally liable for actions of business
- Taxes pass to the owners, and there is no double taxation.
- It is highly regulated and varies state by state
What is the Most Popular Type of Business?
Wondering what the most common types of company ownership are is a common question. During the last decades, a trend has shown that sole proprietorships have become the most popular type of business structure.
This report from the Tax Foundation
shows the number of each type of business in the USA in 2010:
Out of 37 million businesses that filed tax returns to the IRS in 2010, a whopping 81% were sole proprietors, while S Corps/Partnerships made up only 13.5% of registered businesses that year, and the least popular being C Corporations, which only made up 5.4% of registered companies.
There are currently no solid numbers on the percentage of LLCs in the U.S. Still, an educated guess would put the number somewhere between sole proprietorships and partnerships (likely 10-15 million).
How to Choose the Best Type of Business Ownership
There has been a lot of information, so here's a quick rundown of why you might be better off using certain business types.
When can you consider creating a sole proprietorship?
- Want to be your own boss
- Want complete control of your business
- Don't want your profits to be taxed twice
- Are you an undocumented immigrant without Social Security Number (SSN)?
When can you consider creating a partnership?
- You don't want to run a business alone, but you don't want to create a corporation.
- Have family, friends, or partners with whom you want to start a business (make sure you can't trust them altogether).
- You don't want to pay dividends to shareholders.
- You don't want to deal with stricter regulations and reporting.
When can you consider creating a corporation?
- Want your business to be completely separate from you legally
- Want to attract investors and have an easier time getting approved for loan financing.
- Want your business to continue running even after you quit or die
- Are you willing to take on stricter regulations by frequently updating reports on your company's financials and business structure?
When can you consider creating an LLC?
- You don't want to be personally liable for the debts and obligations from your business.
- You don't want to deal with multiple taxations and create a separate legal entity.
- You are not a U.S citizen (having no Social Security Number)
- You are aware of the regulations in your state and do not plan to move from one state to another very often.
Finding the correct legal formation for your business is crucial, and doing so will set you up for success down the road.
Today, there are 4.65 million Hispanic-owned businesses, representing approximately 14% of companies in the U.S. Many of these businesses were smaller (sole proprietorships), and around 30% were home-based businesses.
Latinos were also more motivated to start their own businesses (they were as much as 1.5 times more likely than the general population to start their own business).
Latinas have especially become a growing force in the business sector. In California alone, the number of Latina-owned businesses had increased by 111 percent. Of these Latina-owned businesses, 9 in 10 are sole proprietorships with no employees.
Latinos tend to stray from and leave the corporate sector in terms of corporations. Latinos fill only two percent of corporate board seats and four percent of corporate executive positions. There are currently 9 CEOs at the head of Fortune 500 companies.
Many Latino and Latina entrepreneurs seem more interested in going it alone or finding boundaries preventing them from climbing the corporate ladder.
Undocumented Business Owners
Many would assume that the undocumented portion of the Hispanic population would not be working, much less running their own company. However, in reality, 10% of undocumented immigrants are entrepreneurs running their own small businesses.
Approximately 950,000 undocumented immigrants work either as independent contractors or as owners of their businesses.
This is because it is possible to start a business using only an Individual Tax Identification Number (ITIN) instead of a Social Security Number.
These are not always one-person businesses either, as some undocumented immigrants even have their own employees, some of which are U.S. citizens.
As stated at the beginning of this article, some states have regulations preventing anyone but U.S. citizens from creating or owning corporations, so most undocumented immigrants are sticking to a business ownership structure like a sole proprietorship, partnership, or limited liability company.
Get the financing you need to start your business
Types of business ownership FAQs
Which type of business ownership has double taxation?
A few business owners have double taxation, like C corporations. This business is taxed twice, once at the corporate level and again at the shareholder level.
S corporations and limited liability companies (LLCs) are also taxed twice at the individual level rather than the corporate level. Partnerships are not double taxation, but their owners may be subject to it if they file individual taxes.
Which form of business is the easiest to start?
The most accessible type of business ownership to start is a sole proprietorship.
With a sole proprietorship, you are the only business owner responsible for all business aspects. This includes things like marketing, accounting, and customer service.
How do I classify my business?
There are a few different ways to classify your business. The most common way is by structure, including sole proprietorships, partnerships, corporations, and limited liability companies (LLCs).
Other ways to classify your business include industry, function, or size.
What type of business structure is tax-exempt?
Several types of business structures may be eligible for tax exemption. For example, nonprofit corporations in the United States are typically exempt from paying federal income taxes.
Other businesses eligible for tax exemption include religious organizations, educational institutions, and charitable organizations