What is the best business structure in the United States?

If you’ve recently relocated to the United States or you’re thinking about it, you might be interested in starting a business. After all, one of the most alluring aspects of the American Dream is the potential to become financially self-sufficient. Whether you’re hoping to open a convenience shop, create an online language school, or something else, you’ll need to know the best legal structure to use when setting up your business.

It can be a bit overwhelming when first approaching the subject because of all the different rules, titles, and tax information. You may be asking yourself, “What is an LLC?” or, “What’s the difference between a co-op and a nonprofit?” Those questions are only natural, and we’re here to help.

To give you a clearer idea of how each type of business works, we’re going to go over the possibilities. In this article we’ll discuss different ways you can organize your business looking specifically at the liability, taxes, and the kind of flexibility you’ll have to operate.

In this article, we will use multiple phrases and terms that are specific to how businesses work in the United States. Because of this we’ll include a section called “Important business terms and definitions.” If you read a phrase you haven’t heard before, hopefully we will have the definition in that section.

In this guide, we will answer the following questions:

• What are the different types of business structures in the United States?
• What is a Sole Proprietorship?
• What is a Partnership?
• What is a Limited Liability Company?
• What is a Subchapter C Corporation?
• What is a Subchapter S Corporation?
• What is a Nonprofit Corporation?
• What is a Cooperative (Co-op)?
• What are the important things to consider when choosing a business type?

What are the different types of business structures in the United States?

When starting a business in the U.S. as an immigrant, choosing the right ownership structure is key. The type of business you open plays a role in this decision, and different structures offer various benefits. Whether you’re opening a restaurant, a cleaning service, or even a small construction company, you’ll have to decide between a sole proprietorship, LLC, or another business structure.

For those looking for more liability protection or planning for future growth, an LLC is a popular option. It offers personal asset protection and flexibility in how you manage the business. For larger ventures, like opening a chain of grocery stores or tech startups, incorporating as an S corporation or even a C corporation can help you attract investors and grow the business long-term.

Each business type has its advantages, and the best choice depends on your goals, the size of the operation, and how much risk you’re willing to take on. Below, we’ll dive into the details of each business model.

What is a Sole Proprietorship?

A sole proprietorship is the simplest way to set up a business. In this structure, one person is fully responsible for all the profits and debts. If you want to run a business on your own, maybe from home without a storefront, a sole proprietorship gives you complete control. However, keep in mind that this structure doesn’t separate your personal assets from your business assets, which can create issues as your business grows and liabilities increase.

At the start, you might have expenses like self-employment taxes, equipment leases, office space, and payments for professional services like legal advice or marketing. Common examples of sole proprietorships include freelance graphic designers, personal trainers, landscapers, and housekeepers. But certain professions that require licenses, like doctors or lawyers, can’t operate as sole proprietorships.

Setting up a sole proprietorship is pretty straightforward. There’s not much paperwork since you don’t have partners or board members and you don’t always need to file official business documents. However, you will need to report how much money you’ve made to the government on your tax returns. So, while you don’t have to establish a separate LLC or corporation before you begin doing business, you will still be in good financial standing with the government as long as you accurately report and pay your taxes.

When filing taxes, your business and personal finances are considered one entity. You’ll report your business income and expenses on your personal tax return, typically using Form 1040 along with Schedule C. Then, you’ll use Schedule SE to determine your self-employment tax, which covers Social Security and Medicare contributions.

Closing a sole proprietorship is just as simple as starting one. For example, if you have a graphic design business and choose to close it, you just stop operating and advertising. Many well-known companies began as sole proprietorships before growing into multimillion-dollar businesses. For instance, Apple started as a small operation before it became a corporation.

What is a Partnership?

A partnership is a business where two or more individuals share ownership and responsibility. Each partner contributes in different ways, such as with money, property, skills, or labor. In return, the partners share the profits and losses of the business.

When entering into a partnership, it’s smart to create a legal partnership agreement. This agreement outlines how decisions will be made, how profits will be divided, how disputes will be resolved, and how to handle changes in ownership or end the partnership if needed.

To form any kind of partnership, you’ll need to register your business with your state, typically through the Secretary of State’s office. After registering, you’ll need to obtain any necessary business licenses and permits, which are different depending on your industry, city, and state.

When it comes to taxes, partnerships must also register nationally with the Internal Revenue Service (IRS). A partnership must file an annual information return to report its income, deductions, profits, and losses, but the partnership doesn’t pay income tax itself.

Instead, profits and losses pass through to the partners, who report them on their personal tax returns. This includes income tax and self-employment tax. Partners should receive a Schedule K-1 (Form 1065) from the IRS to report their share of the partnership’s income. Now, let’s briefly discuss some specific types of partnerships.

General Partnership

In a general partnership, profits, liabilities, and management responsibilities are divided equally among partners. If you decide on an unequal distribution, it should be documented in the partnership agreement.

Limited Partnership

In a limited partnership, some partners have a more active role in managing the business, while others are more like investors. The partners who are actively involved share in the day-to-day decisions, while the limited partners typically have a smaller role and are only responsible for the business up to the amount of money they invested. The key benefit for limited partners is that they’re only responsible for covering the amount of money they agreed to invest. So, if the business takes on debt or faces legal issues, they won’t lose more than what they put in.

Joint Venture

A joint venture is similar to a general partnership but is created for a specific project or period of time. Joint ventures are often used for one-time business deals, like developing a real estate property or completing a specific construction project.

Limited Liability Partnership

A Limited Liability Partnership (LLP) is a popular business structure for law firms, medical practices, and other groups of licensed professionals. It lets professionals work together and share resources without risking their personal finances.

In an LLP, partners are only responsible for debts or damages caused by their own actions, or for the amount of money they’ve invested in the business. This means they aren’t held personally liable for the mistakes or debts of other partners.

What is a Limited Liability Company?

A Limited Liability Company (LLC) is a type of business in the U.S. that helps protect its owners’ personal assets. If the business is sued or owes money, the owners’ personal finances, like their bank account or house, are usually safe from being taken to pay off business debts.

An LLC is like a mix between a corporation and a partnership or sole proprietorship. Like a corporation, the owners, who are called “members,” aren’t personally responsible for the company’s debts. Yet, unlike corporations, LLCs can pass business income directly to the owners, who pay taxes on it personally, similar to how partnerships work.

An LLC is a business structure that’s regulated by state law, and each state has its own rules. In most states, there aren’t many restrictions on who can be a member. This means individuals, corporations, other LLCs can all be members. There’s also no limit on how many members an LLC can have. Plus, many states allow LLCs with just one owner, called a single-member LLC.

What is a Subchapter C Corporation?

A “C corporation,” or “C corp,” refers to Subchapter C of the Internal Revenue Code, which outlines the tax rules for this type of business structure.

C corporations are legally separate from their owners. They can make profits, pay taxes, and be held responsible for their actions.

One of the greatest advantages of a C corp is that it offers strong protection for its owners from personal liability. However, setting up and running a C corporation can be more expensive and complex compared to other business structures. C corporations must keep detailed records and follow specific operational rules such as having a board of directors and holding annual meetings.

Unlike sole proprietors, partnerships, and LLCs, C corps pay income tax on their profits. Sometimes, profits are taxed twice. The first time is when the company earns income and again when shareholders pay taxes on dividends they receive personally.

C corporations can continue to operate even if an owner sells their shares or leaves the company. They also have an advantage in raising money because they can sell stocks, which is helpful for attracting investors and employees.

What is a Subchapter S Corporation?

This business structure, known as an “S corporation” or “S corp,” refers to Subchapter S of the Internal Revenue Code.

An S corporation is a special type of corporation designed to avoid the double taxation that regular C corporations face. With S corps, profits and some losses pass directly to the owners’ personal income without being taxed at the corporate level.

The tax treatment of S corps is different in each state. Most states recognize them in the same way the federal government does. However, some states tax S corps on profits above a certain amount, while others do not recognize S corps at all and treat them as C corporations.

To obtain S corp status, businesses must file with the IRS, which is a different process from registering with the state.

S corps have specific rules to qualify. First, the corporation must be located and operated in the U.S. It can have no more than 100 shareholders and can only issue one type of stock. Also, ownership is limited to U.S. citizens, U.S. residents, certain trusts, and estates.

S corps offer some tax advantages, but they still need to follow the same formal rules as other corporations. This means they have to file important documents and keep accurate records, just like C corporations do.

Like C corporations, S corps have an independent existence from their shareholders. This means that if a shareholder leaves or sells their shares, the S corp can continue operating without interruption.

What is a Nonprofit Corporation?

Nonprofit corporations are set up to carry out charitable, educational, religious, literary, or scientific activities. Since their work benefits the public, they can qualify for tax-exempt status, which means they don’t have to pay state or federal income taxes on any profits they make.

To receive this tax exemption, nonprofits need to file with the IRS, a process separate from state registration.

Nonprofits must follow rules similar to those of regular C corporations such as having a formal structure, filing requirements, and complying with state and federal regulations. They also have special regulations regarding how they handle any profits. For example, they cannot distribute profits to members or support political campaigns.

You might hear nonprofits referred to as 501(c)(3) corporations. This name comes from the section of the Internal Revenue Code that commonly provides tax-exempt status.

What is a Cooperative (Co-op)?

A cooperative which is often called a “co-op,” is a business that is owned and run by its customers. In a co-op, all the owners and operators are also users of the products or services it provides. What makes cooperatives unique is that their main focus is on benefiting the members and the community, rather than just making a profit. While they do need to generate income to stay operational, cooperatives typically reinvest their profits back into the business instead of distributing them to owners or shareholders.

Though nearly any organization can be owned cooperatively, there are a few main types of cooperatives. For example, agricultural co-ops bring together farmers and other agricultural professionals who pool their resources to purchase bulk supplies like fertilizer, seed, and fuel. Artists and craftspeople also create cooperatives to share studio space, buy supplies in bulk, and distribute their creations using shared retail space. Food store co-ops serve as grocery stores that offer special prices to members and provide communities access to a wide variety of high-quality produce at a lower cost. These are just a few types of common co-ops, and if you believe that your business might be a good cooperative, it’s smart to speak to a professional.

What are the important things to consider when choosing a business type?

When you’re trying to choose a business structure, you might be thinking about the pros and cons first. For example, you might be asking yourself what business model takes the least amount of paperwork to start. Or, you might be wondering which company structure will allow you to raise money from your community. So, let’s go over the common considerations most people make when they’re trying to choose a business structure.

Taxes

When choosing a business structure, it’s important to understand how taxes will impact your finances. Sole proprietors, partnerships, and S corporation owners report business income as personal income, which can sometimes lower taxes but also means paying self-employment taxes.

C corporations are taxed separately from their owners, but their profits get taxed twice, once at the business level and again when dividends are paid to the owner. Your choice of business structure affects your overall tax responsibility, so it’s important to think about both federal and state taxes before deciding.

Although we’ve already gone over some tax information, below we will use a table to show a more clear idea of the exact tax expectations for each business structure we’ve covered.

Liability

“Liability” refers to the legal responsibilities for debts or obligations, meaning a person or business may need to meet financial commitments when payments are due or obligations arise. Different business structures provide various levels of personal liability protection.

For example, sole proprietors and partnerships usually have unlimited personal liability, which means the owners’ personal assets, like homes or bank accounts, can be at risk if the business faces legal issues or debts.

In contrast, LLCs, C corporations, and S corporations all offer different degrees of limited liability protection. This means the owners are usually not personally responsible for the business’s debts or legal obligations. If the business is sued or incurs debt, only the assets owned by the business are at risk.

Cooperatives provide limited liability, which means members’ personal assets are protected from the co-op’s debts. If financial issues come up, members may be asked to contribute extra funds, but they aren’t legally required to do so.

Nonprofits also offer limited liability, keeping personal assets safe from the organization’s debts. They rely on donations and grants, and while board members may seek additional support in tough times, there’s no legal obligation for anyone to give extra help.

Complexity vs. Flexibility

Different business structures can make your life more complicated or simple, but sometimes more complex businesses have their benefits. Each business model offers pros and cons.

Sole proprietorships are the easiest to manage because they have minimal paperwork, but they come with unlimited personal liability, putting your assets at risk. Partnerships allow you to share responsibilities and add structure but can involve complex agreements and shared decision-making.

S corporations have more formalities, such as regular required annual meetings which must be recorded. But, they also provide tax benefits and legal protections that can be very beneficial for business owners. LLCs provide flexibility and protect owners from personal liability, but they also require filing an annual report and paying fees to stay in good standing with the state.

Registration

Registration requirements differ with each business structure. For example, sole proprietorships typically need just a business license, while partnerships may require a partnership agreement and state registration. S corporations must file Articles of Incorporation, which involves more paperwork and fees. Nonprofits, on the other hand, have a lengthy process and specific fees for getting registered with the IRS.

Ownership and Control

Each business structure varies in control over operations and profit distribution. Sole proprietorships give the owner more freedom, allowing for quick decisions without needing approvals. However, this autonomy comes with total responsibility, which can be stressful in difficult times.

Partnerships offer shared ownership, combining partners’ strengths but requiring agreement on decisions. This teamwork can spark new ideas, but disagreements can complicate things. LLCs provide a middle ground, allowing members to retain control while limiting personal liability.

When it comes to C or S corporations, owners would be considered both shareholders and possibly board members. While the person who starts the corporation may be the owner, the daily operations and major decisions may still be influenced by the board’s governance structure, which can limit your ability to make decisions independently.

Investment Needs

Starting a business often involves weighing your funding options carefully, especially if you need money from investors or you want to eventually sell stocks.

Sole proprietorships and partnerships typically rely on the owner’s personal resources to get started and grow. Because these businesses are usually small at the beginning, they don’t attract significant outside investments so funding can be a challenge.

If you’re looking for more substantial investments, it might be wise to consider structures like LLCs or corporations. These options allow for greater flexibility in raising capital, as they can bring in outside investors more easily. This is because, with an LLC or corporation, investors only stand to lose what they’ve invested in the business. Their personal money and belongings are safe, which makes them more comfortable putting funds into a business.

C corporations can attract large investments because they issue shares of stock, but they face double taxation on profits. S corporations also issue stock but avoid double taxation, allowing profits and losses to pass through to shareholders’ personal tax returns. Nonprofits can secure grants and donations without paying federal income tax, while cooperatives focus on member benefits and allow members to invest in the business collectively.

Important business terms and definitions

As you’re researching different business structures, you will probably see some words and phrases that you may not know.

What are self-employment taxes?

Self-employment tax is a tax that people who work for themselves pay to cover Social Security and Medicare. Unlike regular employees, who have these taxes taken out of their paychecks by their employer, self-employed individuals pay the full amount themselves. This is important because it ensures that self-employed individuals contribute to social safety programs in the same way that employees of larger companies do. By paying self-employment tax, they secure their eligibility for future benefits, such as retirement and healthcare coverage.

What are investors?

Investors are individuals or groups that provide money to businesses in exchange for a potential return on their investment. They help companies grow by offering funding that can be used for various needs, like launching products or expanding operations. By investing, they take on some risk but also have the opportunity to earn profits as the business succeeds.

What are stocks?

Stocks are a type of financial asset that represents a small piece of ownership in a company. When a company wants to raise money to expand or invest, it may sell shares of stock through a process called an initial public offering, or IPO. After the IPO, investors who bought shares can resell them on the stock market, where the price of each share can go up or down. These changes in stock prices are often based on what people expect the company’s future profits to be.

What are dividends?

Dividends are payments made by a company to its shareholders as a share of the company’s profits. When a company makes money, it can choose to give some of that money back to the people who own its stock, usually in the form of cash or additional shares.

Who are shareholders?

A shareholder is a person or organization that owns at least one share of a company’s stock. This ownership means they have a claim to part of the company’s profits and may have a say in important decisions, such as electing the board of directors or approving major changes to the company.

What is a board of directors?

Every public company must have a board of directors, and many private companies and nonprofits have one too. A board of directors is a group elected by shareholders to guide the company, oversee management, and protect the interests of the shareholders.

What is pass-through taxation?

Pass-through taxation means that a business’s profits go straight to the owner’s personal tax return, so the business itself doesn’t pay income taxes. The owner just reports the business’s earnings on their own taxes and pays once, avoiding the double tax that some corporations deal with. This keeps things simpler for the owner and avoids extra taxes.

What is capital?

Capital is a term that refers to anything valuable that can help a business or person make money. This includes things like buildings and equipment, ideas protected by patents, or money itself. While cash is considered capital, it usually refers to money that is actively being used for investments or to run a business.

What is a patronage dividend?

A patronage dividend is a monetary payment given to members of a cooperative based on how much they use its services or buy its products. Instead of being paid based on owning shares, these dividends reward members for their involvement, so the more a member participates, the bigger their payment will be.

What is an information return?

An information return is a tax document used to report certain types of income and transactions to the IRS without sending money. So, if you own a business and have employees, you’ll probably have to file information returns, like W-2 forms for employees and 1099 forms for independent contractors, to inform both the IRS and the recipients about the income earned.

What are tax deductions?

Tax deductions are expenses that businesses and business owners can subtract from their total income to figure out how much tax they owe. By reducing their taxable income, these deductions can help lower their overall tax bill. Common examples include costs for office supplies, business travel, and home office expenses. By taking advantage of these deductions, business owners can pay less in taxes and keep more of their profits.

What is double taxation?

Double taxation refers to the situation where the same income is taxed twice. In the case of businesses, this often happens with corporations. When a corporation earns profits, it pays taxes on those profits at the corporate level. Then, when those profits are distributed to shareholders as dividends, the shareholders also pay taxes on that income on their personal tax returns. This means the same money is taxed first at the corporate level and again at the individual level, resulting in double taxation.

Conclusion

Starting a business in the United States can be an exciting adventure for immigrants, but it also comes with its own set of challenges. Choosing the right business structure is a crucial step that can shape your entrepreneurial journey and keep you safe. Whether you are considering a sole proprietorship, partnership, LLC, or corporation, it’s important to understand the implications of each option.

Each business structure offers distinct advantages and requirements, from liability protection to tax implications. One of the smartest things you can do is consult with professionals like business advisors or attorneys who can provide valuable insights for your specific situation. A well-informed choice will help you establish a strong foundation for your business, ensuring you meet the legal requirements and set yourself up for success.

Though we’ve covered taxes briefly here, in our next article, we’ll discuss complying with U.S. tax laws as an immigrant and entrepreneur, in more depth. We will break down the various tax obligations you need to be aware of, including federal and state taxes, sales tax, and self-employment tax. Additionally, we will provide tips on maintaining proper tax records and preparing for annual tax filings, helping you navigate the complexities of the U.S. tax system.

Author: Aaron Randolph | LinkedIn