In Short
- The right business structure in the U.S. affects taxes, liability and operations.
- Sole traders and partnerships are simple but offer less protection.
- LLCs and corporations provide liability protection, with corporations better suited for raising investment.
Tips for Businesses
Choose a business structure that fits your goals. Sole traders and partnerships are best for small, simple operations, while LLCs and corporations suit businesses needing liability protection or investment. Consider tax implications, risk and future plans when deciding. Always get advice to ensure you make the best choice for your needs.
When establishing or expanding a business to the United States, choosing the right business structure is an important step that impacts tax obligations, liability risk and operational flexibility. This article discusses the most common business structures in the United States, highlighting their key features, advantages and legal considerations so that you can choose the right structure for your business.
Sole Trader
This is the simplest structure to start a business with, as it does not require a lengthy application process. Generally, a person files to register their business name, opens a business bank account and obtains any necessary business licences or permits required in their state. Under this structure, the business is operated by an individual in their personal capacity. However, this means there is no distinction between the assets of the person and those of the business.
Benefits of being a sole trader include:
- a simple setting-up process;
- maximum control, as you are the only one who can make decisions; and
- simple taxation, since you report business income and expenses on your personal tax return.
However, drawbacks of being a sole trader include:
- unlimited personal liability (any business liability is your liability, and your personal assets may be seized to pay business debts);
- difficulty in accessing capital or investment, since no one would want to invest in a person; and
- the business winding up or being inherited on your death.
Partnership
A partnership is a type of structure where two or more people come together to establish a common venture, with the intention of sharing profits and losses. The two main types of partnerships are:
- General Partnerships: All partners have equal control and responsibility.
- Limited Partnerships: Some general partners have unlimited liability, and some limited partners who invest in the partnership have limited liability.
Benefits of forming a partnership include the ability to:
- share profits and losses in accordance with a partnership agreement; and
- obtain investment by bringing on new partners.
Additionally, partnership profits are not taxed twice, and profits distributed to partners are only taxed in each partner’s personal tax return. However, the partnership is still required to file an informational tax return with the IRS.
Drawbacks of forming a partnership include:
- the potential for shared liability if there is not a written partnership agreement in place; and
- limited options for obtaining investment from third parties due to lack of stocks (investment is usually limited to bringing on new partners with industry experience to work in the partnership).
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Limited Liability Company (LLC)
A limited liability company (LLC) is a structure relatively unique to the United States. The best way to explain it is as a hybrid of a partnership and company. This is because although it is a separate legal entity with limited liability, unlike a company, it does not have shareholders. Instead, an LLC has members who each own an interest in the business but do not hold stocks or shares.
This means that when the business generates profits, they are generally not taxed until they are distributed to members. After distribution, they are taxed as income for the members rather than the business, unless a different tax treatment has been chosen with the IRS.
Benefits of incorporating an LLC include:
- having the liability protection of a company but with the tax treatment of a partnership;
- generally, no tax at the LLC level, meaning profits are only taxed once (when members report them on their personal tax returns); and
- lower cost to operate compared to a corporation.
Drawbacks of incorporating an LLC include:
- a lack of stocks, making it difficult to attract investors or set up employee stock option plans (alternatives are available but are complex); and
- in some states, a member leaving the LLC can trigger a winding up of the LLC.
Corporation
A corporation (also called a ‘c-corp’) is essentially what is known as a ‘company’ in most jurisdictions. It has shareholders, stocks and a board of directors. Like an LLC, it has limited liability but has more rigid management. However, because it has stocks, it is a popular option due to the ease of seeking investment and setting up employee stock option plans.
Most new businesses looking to go public or be acquired will opt to structure as a corporation. Unlike the other structures discussed earlier in this article, corporation profits are taxed twice, once at the corporation level and again at the shareholder level.
In some cases, a corporation can elect to be taxed as a partnership so that profits are only taxed once (known as an ‘s-corp’). However, this limits the ability to have multiple classes of stock and unlimited shareholders. Generally, an s-corp can only have U.S. citizens or residents as shareholders. Additionally, some states do not even recognise s-corps and merely treat them as c-corps.
Benefits of incorporating a corporation include:
- limited liability;
- stocks, making it the popular option to attract investors or set up employee stock option plans; and
- continuity of business even as shareholders come and go.
However, there are also drawbacks to incorporating a corporation, including:
- double taxation, since the corporation’s profits are taxed, and then those profits are taxed again when they are distributed to shareholders (in each shareholder’s personal tax return); and
- more rigid management due to having a board of directors.
Key Takeaways
Choosing the right business structure can give you the best chance of success in the United States. When considering which structure is right for you, remember that:
- sole trader and partnership structures may be simpler to set up and operate, but often afford less liability protection;
- LLCs and corporations, on the other hand, offer better liability protection but require more effort to operate; and
- if you are looking to issue stocks or seek investment, then a corporation is likely the best structure for your business.
If you want to learn more about doing business in the United States, call us today on 1300 544 755 or send us an enquiry.
Frequently Asked Questions
You should consider liability protection, taxation, operational complexity, investment needs and future business goals. Running your business as a sole trader or partnership is ideal for small businesses when you are not seeking investment. However, corporations are ideal for raising capital, while LLCs provide liability protection with simpler taxation.
An LLC offers liability protection and single taxation, meaning profits are only taxed when distributed to members. However, a corporation provides stocks, making it easier to raise investment or go public, but profits are taxed twice, at the business level and again when distributed to shareholders.
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