How to Choose the Right Business Structure

Choosing the right business structure is one of the most important legal decisions for entrepreneurs. While many choose an LLC, it’s worth exploring other options too. Here are the three most common structures for new businesses today:

• Sole Proprietorship

• Limited Liability Company (LLC)

• Corporation

Sole Proprietorship

If you start your business without filing anything with your Secretary of State, you’ll be considered a sole proprietor. While I generally don’t recommend running a full-time business as a sole proprietorship, it can work for some entrepreneurs. Many of my clients in Boulder and Kansas City successfully operate under this structure.

A sole proprietorship is the simplest business structure. You can operate under your name or adopt a “doing business as” (DBA) or “fictitious name” for marketing purposes. You will report all business profit (or loss) on your personal income tax return using an IRS Schedule C and you can deduct business expenses to reduce your taxable income.

However, the major downside is that you are personally liable for everything that goes wrong in your business, including all business debts. If you have employees or contractors, you might be personally liable for their mistakes too. Personal liability means that claims against your business could result in judgments against your personal assets, such as your home, car, or even wages. This is a significant risk that should be avoided if possible.

If you only have a few clients a year and your goods or services present minimal risk, a sole proprietorship might be acceptable. But if your business grows beyond that, I usually recommend forming an LLC or another structure. Typically, I suggest creating your LLC in the state where you operate, which for my clients is often Colorado, Kansas, or Missouri. That said, you can incorporate your LLC in any state.

Partnership Alternative: If you start a business with co-founders without filing anything with your Secretary of State, you may unintentionally create an “accidental partnership.” Partnerships are similar to sole proprietorships but involve multiple owners. Each partner is personally liable for everything that happens in the business, including the actions of other partners, employees, and contractors. Additionally, partnerships must file a tax return with the IRS, and each partner reports their share of profit or loss on their personal tax return using an IRS Form K-1. Given these risks, it’s generally best to avoid accidental partnerships unless you’re fully aware of the implications.

Limited Liability Company (LLC)

Most of my entrepreneurial clients choose an LLC for their new businesses. You create an LLC by filing formation documents with your Secretary of State. An LLC can have one owner or multiple owners.

The biggest benefit of an LLC is that the owners are typically not liable for things that go wrong in the business, its debts, or the actions of employees or contractors—though there are exceptions to this limited liability.

One of my favorite features of LLCs is the flexibility in taxation. Owners can choose whether the business is taxed as a sole proprietorship, partnership, corporation, or an “S-Corp,” which can offer significant tax advantages.

Another advantage is that if you start with an LLC but later need to change to a corporate structure, you can do so easily.

Corporation

Most new companies don’t start as corporations, but if you plan to raise capital from professional investors (beyond family and friends), this might be the best structure for you. You create a corporation by filing formation documents with your Secretary of State. A corporation can have one shareholder or many.

Like LLC owners, corporate shareholders are generally not liable for the company’s debts or the actions of employees and contractors. However, exceptions to limited liability do exist.

The default tax structure for corporations can lead to what is called “double-taxation”: the corporation pays taxes on its income, and then shareholders also pay taxes on distributions. This can result in higher overall tax bills compared to other structures.

Corporations also require more formalities, such as officer requirements, annual meetings, and additional record-keeping—often referred to as “red tape.” While not ideal for most new businesses, corporations can be the right choice if you need the advantages they offer. If you think this might be the case, consult with an entrepreneurship attorney.

A Note About S-Corps

You might be wondering, “What about S-Corporations?” An S-Corp is not a separate business structure. Instead, it’s a tax election that an LLC or corporation can make, which can sometimes help reduce your tax payments. See this guide for more.

(This article is general in nature and is not legal advice.)