What is Business Structure? Common Business Structures Explained

 Business structure is defined as an organizational framework for carrying out commercial activities. It is a legally recognized structure that is characterized by its category.

The structure you choose influences your ability to raise money, paperwork, personal liability, and how much you pay in taxes.

Meaning of business structure

Once you have decided to form a business entity the first thing you have to do is choose the structure because only then you will be able to register your business and take up the next steps for its formation.

It is vital to research properly before making your choice because in some cases you cannot shift your structure once you have registered it and have started its daily operations and in other cases, it is a great hassle that will drain you of money, effort and time.

Common business structures

Some of the most common business structures are as follows-

#1. Sole proprietorship

It is an unincorporated business structure which is owned by a single individual. People who are self-employed and freelancers are legally operating a sole proprietorship business.

This type of business has pass-through taxation as the business does not file a return instead the owner files it as his tax return via Schedule C. The liability of a business becomes the owner’s liability and the risk can be mitigated via the help of sound contracts and insurance.

The owner has full control over this business structure which is cheap and easy to set up. The disadvantage of a sole proprietorship business structure is that the owner is personally exposed to the risk and is responsible for all its debts and liabilities.

#2. Corporation

It is considered a complex business structure and is owned by numerous stockholders. It is a legally independent entity and is responsible for its debts and actions and is responsible for the payment of taxes.

The corporation has the power to enter into separate contracts from those of its shareholders. This form of structure is appropriate for larger companies with numerous employees.

The number of stocks someone has decided about his ownership in the company. The shareholders have limited liability, and they are not personally responsible for the liabilities and debts of a business.

An important disadvantage of an LLC is that it proves a costly business to set up, and there is a high level of oversight and governance by the elected board of directors.

The corporation is further divided into

#1. S-Corp as a Business Structure

The S-Corp business structure has to report credit, deductions, gains, loss, and profit on Form 1120S. The entity passes corporate credit, deductions, profit, and loss for Federal tax purpose to their shareholders, who in turn report about it on their tax returns.

#2. C-Corp

This type of business structure is recognized as a separate tax-paying entity for Federal income tax purposes and has to file its tax return. It is subjected to corporate income tax on corporate profits.

The shareholders will have to personal income tax on the distributed corporate profits. It is thus an entity that has to pay double taxation.

#3. Partnership

This type of business structure is an association between two or more people who are the partners in a firm. It is necessary to create a partnership agreement to make matters clear and precise.

The agreement stipulates the terms by formalizing the rules for management rights, dissolution terms, banking procedure, bookkeeping, capital contributions, percentage of owner’s share and sharing of profit and loss and is created by an attorney. It is legally binding for every partner.

A partnership firm is a tax-reporting entity that must file an annual information return in Form 1065 with the IRS. It does not have to pay Federal income tax, although it has to report all its income and loss from its business activities.

As per the sharing structure in the agreement, the profit/loss is divided between the partners. Each partner has to pay the tax as per his share. Although the partners have an unlimited number of personal liabilities, they are jointly liable for the obligations of the partnership firm.

An important disadvantage of partnership business structure is that the partners are liable for the liabilities and debts of the business entity, and the profit has to be shared between them.

#4. Limited Liability Corporation

This business structure is considered a hybrid between sole proprietorship, general partnership, and a corporation. Several states permit the creation of a Limited Liability Company with one member although the members can include other LLCs, corporations, individuals and foreign entities.

For tax purposes, a Limited Liability Company is a pass-through entity as the income from the business passes to the LLC members who have to report about their share of profit or loss on their personal and individual returns.

The Limited Liability Corporation has to file an informational tax return. Due to the concept of limited liability, the members are protected from personal liability for debts and claims of the business.

This means that if the company faces a lawsuit, only the assets of the business and not the personal assets of the owners are at risk. Except in the case of fraud or illegality creditors cannot demand the personal assets of any member.

At the time of establishing an LLC, you will have to pay a filing fee and acquire the articles of organization. It is important to sign an agreement that will set out the rules for operations and ownerships.

The legal agreement includes buying and selling provision, management structure, and voting power of the members, allocation of profit and loss, the responsibilities and rights of each member as well as their ownership interest. The main disadvantage of an LLC business structure is that it is subjected to additional taxes at the state level.

#5. Co-operative Business Structure

This type of business structure is owned as well as run by the people that use its services. The generated profit is distributed amongst the members. Co-operative is a common structure in several industries like restaurant, agriculture, retail, and healthcare.

Members become a part of a co-operative with the help of the shares it has purchased. The amount of these shares does not increase or decrease their power in the meetings as one member has one vote irrespective of the number of shares with him.

There is an elected board of officers and directors who have the responsibility of running the show, and the regular members have a voting power to control the direction of the proceedings in these meetings.