Business Startups – Know These Business Structures

Business Startups - Get Familiar With These Business Structures

Business Startups – Get Familiar With These Business Structures

Business startups are not for the faint of heart. Someone, long ago and far away, shared some advice when I joined the ranks of the self employed. He said, “don’t think of it as being self employed, it’s more like being self inflicted!” Joking aside, despite the challenges, I wouldn’t have it any other way.

Many entrepreneurs have a desire to begin a business but are unsure about the steps to take to get started with their enterprise. Which structure you choose can effect taxes, liability, the operation of retirement plans, and health benefits.

Whether you are starting a new business or expanding an existing one, selecting the right business structure is a huge decision. You don’t need to become an expert in law or accounting. You do need to become familiar with the basics and work closely with a team of professionals to ensure everything is done right at the beginning, and thereafter.

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Business Startups – Know These Business Structures

Sole Proprietorship:

By default, when an individual goes into business in California without a formal company, the law deems them to be a sole proprietor.  These individuals often provide services or sell goods on a small scale and report their earnings on their personal tax return. This income is reported on Schedule C or C-EZ and attached to Form 1040. According to the IRS tax form, Schedule C-EZ may be used instead of Schedule C if:

  • Has business expenses of $5,000 or less
  • Use the cash method of accounting
  • Did not have an inventory at any time during the year
  • Did not have a net loss from your business
  • Had only one business as either a sole proprietor, qualified joint venture, or statutory employee
  • Had no employees during the year
  • Do not deduct expenses for business use of your home
  • Do not have prior year unallowed passive activity losses from this business
  • Are not required to file Form 4562, Depreciation and Amortization, for this business

There is no liability protection from third parties afforded to sole proprietors. If you are are sued for your business activities as a sole proprietor, you could be personally liable for damages.

The major advantage to using a sole proprietorship is that it is extremely simple; beyond a business license, there is not much else required of a business owner to run the company. Additionally, you have full control over the business and there is no sharing of profits.

Business Startups

Business Startups


Akin to a sole proprietorship, a general partnership is the default business structure when two or more people start a business enterprise with the purpose of making a profit.

Partnership taxation is similar to the way a sole proprietorship is taxed. The partnership is not a separate entity for tax purposes. Each partner must report their portion of the partnership income on their personal taxes. While the partnership does not pay taxes, it is required to file a return and Schedule K-1.

Some advantages of partnerships include sharing of responsibilities, no double taxation of income, and ease of formation.

There are some significant legal drawbacks to partnerships, among which is the fact that all partners are liable for all of the business dealings of any of their partners. In addition, it can be difficult for a partner to sell their interest in the partnership. A formal partnership agreement is recommended whenever a partnership is used.

Limited Liability Company:

LLCs provide the most degree of flexibility in structuring a company. Members are the owners of the LLC. Managers are those individuals who carry out the day-to-day business of the LLC.  Having a carefully-drafted Operating Agreement in compliance with California law is vital to the proper functioning of the LLC.

Pass-through taxation, similar to a partnership, is the main advantage of an LLC versus a corporation.

A significant advantage of employing an LLC structure is that provided certain conditions are met, the company can serve as a legal shield against the owners from third-party claims.

Some disadvantages include limited ability to raise capital, can be expensive to form, and conversion to an LLC may have adverse tax consequences.


The corporation (whether an “S-Corp” or a “C-Corp”) is the best established business structure in California.  Shareholders own the company.  The shareholders appoint a board of directors to make high-level decisions for the business.  The board of directors, in turn, hire officers, including a President, CFO, and a Secretary at a minimum.  The corporation also provides legal separation from the shareholders and the corporation’s debts and liabilities. There may also be some significant tax savings by using a corporate form.

Some disadvantages include double taxation of dividends, ongoing corporate formalities, and costly formation and operations. Corporate income is reported on U.S. Corporation Income Tax Return Form 1120.

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Considerations for Business Startups:

  • Liability – As you can tell, liability is a theme that runs throughout these business formations. Which one you choose will determine the level of personal liability to which you are exposed. Careful insurance planning is key.
  • Taxes – How income is taxed varies significantly between the structures. It is not always about which one is better, but rather understanding the pros and cons.
  • Retirement plans – There has been a lot of progress over the years leveling the retirement plan playing field for various business structures. However, there are still important considerations with regards to retirement plans. Remember, retirement plans are a benefit on one hand and a way to significantly minimize taxes of the business on the other.
  • Health benefits – Similar to retirement plans, the type of health plans available vary as do the ways in which plans are taxed.
  • Estate planning – Without careful planning, the death of a business owner could mean an end to the business and a significant loss to the owner’s family.

Please remember this summary for business startups is not legal, investment, or accounting advice. Make sure to consult an attorney and accountant for guidance on your specific circumstances.

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Robert Sanders, Attorney at Law contributed to this article.

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