What is the legal structure?

The first step for the establishment of any company is to find a suitable legal structure. To determine the appropriate legal structure for a specific company or a venture, professional guidance is necessary for the deep understanding of various structure classifications, long-term targets, and certain choices. The categorization of different business legal structures comprises liability implications, income and taxation considerations for the company owners.

Selection of a business structure

A business structure affects day-to-day performance and is a possible threat due to exposure of one’s assets. Thus, it is essential to pick a correct business structure for the correct balance of legal rights and advantages. The personal liability, taxation amount, permits and paperwork, all depend on the business structure. Changing into another business structure is feasible but comes with certain restrictions, hence approaching for the right business structure and choosing it wisely holds utmost importance. Some of the business or legal structures are outlined below.

Sole Proprietorship

Sole proprietorships are the most popularly used legal structures for start-ups or small organizations owned and operated by a person with no difference between the business and the founder.

It is simple to create a sole proprietorship that provides full control over the business. If a person is associated with business activities without any registration of the organization, then that person is considered to be a sole proprietorship. The business and the personal assets are combined as sole proprietorships don’t create another business entity. They are taxed as pass-through entities, all the assets produced by the firm are the personal income of the founder for taxation. It implies that the business won’t file a tax return and instead, the finances are passed through and recorded on the personal tax of the owner.

The disadvantage of sole proprietorships is the personal liability protection, which means that if someone happens to take up their business, then it will be termed as a separate legal entity. Another drawback is that a sole proprietorship can consist of a single owner and many investors may be reluctant to invest money in these types of business structures.

Advantages of a sole proprietorship can be that the owner has absolute control over its business and sole proprietorships are simple and less expensive to initiate the enterprise.

General partnership

The alliance or confederation of two or more people to go into an occupation aiming for gain or profit while working together. Partnerships are made when at least two people as co-owners are involved to grow the business that stands for the benefit of both the partnered parties by agreeing and signing legal documents related to the collaboration as proof.

A general partnership needs to file an information return with the Internal Revenue Service (IRS) yearly to disclose any losses or money-related issues but does not give any federal income tax making it a tax-reporting business structure. The company holders enjoy unlimited personal liability with each party having individual partnership responsibilities.

Advantages of a general partnership include simple creation and maintenance and also the gains and losses are passed to the holder’s tax returns.

The drawbacks of a general partnership are that both parties are individually responsible for debt and without legal paperwork, management problems may occur.

The formation of general partnerships is simple but the decisions made, if not with the interests of one partner, do not affect the liability share. The general partnerships are of two types namely limited partnerships (LP) and limited liability partnerships (LLP).

Limited partnerships comprise of single general partner with unlimited liability, and limited liability to all other partners whereas in limited liability partnerships, they are given liability constraints to each owner but provide protection against debts and are not responsible for the activities of other partners.

Limited Liability Company (LLC)

LLC is the amalgamation of an organization, general partnership, and sole proprietorship with owners exclusively known as members. Generally, the states allow the limited liability company with a single owner known as a single-member LLC. Similar to the general partnership, a limited liability company needs to file an informational tax return and is a pass-through entity like a sole proprietorship. The LLC members are subjected to limited liability protections from personal liability to them, in case it faces a lawsuit, the business assets are at risk and even creditors cannot reach the member assets, illegal actions and fraudulent practices being an exception.

The limited liability company is similar to corporate bylaws and is an agreement that lays regulations for ownership and running the businesses,

Certain advantages are having limited liability, gains, and losses taxable at personal levels and permits innumerable members. Drawbacks include additional taxation and every member’s profit shows taxable income, even when the profit was not given equally or at all.

A limited liability company represents a business entity and is not the same as a limited liability corporation. To summarize, the components of a limited liability company are that its business structure restricts personal liability, eradicates double taxation, unlimited members, general partnership and sole proprietorship merger, self-employed taxation, and developing laws.

Corporations

Corporations are the most complicated forms of business structure. Various types of corporations include C-Corp, S-Corp, B-Corp, close corporations, and non-profit corporations.

C corporation (C-Corp)

The C corporation (C-Corp) is a legal entity separate from the company holders. It provides the best liability protection but the finances are higher when compared to other types of structures. Also, unlike other structures, the C corporation pays taxes on profits and it remains unaffected by the involvement of the shareholders.

S corporation (S-Corp)

The Subchapter corporation (S-Corp) is established to permit profits and certain losses given directly to the owner’s own income with any corporate taxes and also prevent double taxation. It should file in confidence with the IRS an annual information return. They also enjoy an independent life unaffected by the absence or presence of the shareholder.

B corporation (B-Corp)

The benefit corporation is especially a for-profit corporation officially recognized mostly by the U.S. states. The B corporations are made up of both gain and mission. The stakeholders hold the organization responsible for public benefit along with economical gain. Sometimes, they need to deliver yearly benefit reports to show their work towards the assistance of the public.

Close corporation

Close corporations are similar to B corps but with a lesser traditional corporate structure. These ignore many formalities that usually apply to smaller companies. 

Non-profit corporation

Non-profit corporations are built for charity, child care, literacy growth, religious and scientific work, majorly for the underprivileged and other backward communities for giving equal opportunities. They get tax exemptions as it is beneficial for the public. 

Context and Applications

• Bachelors in Technology (Civil Engineering)
• Masters in Business Administration (Finance and Banking)
• Bachelors in Commerce (Economics)
• Bachelors in Commerce (Accounting)

Practice Problems

1. What is the full form of IRS?

1. Internal Revenue Service
2. International Revenue Service
3. Internal Record Service
4. Internal Revenue Society

Correct option- a

Explanation: The full form of IRS is Internal Revenue Service.

2. Which of the following structures is/are the different type(s) of legal structure(s)?

1. S corporation
2. General Partnership
3. LLC
4. All of these

Correct option- d

Explanation: The different types of legal structures are S corporation, General Partnership, and LLC.

3. Which business structure provides no liability protection and has one owner?

1. Non-profit corporation
2. Sole Proprietorship
3. S corporation
4. None of these

Correct option- b

Explanation: Sole Proprietorship business structure provides no liability protection and has one owner.

4. Which corporation is majorly a part of the U.S. states?

1. LLC
2. C corporation
3. B corporation
4. S corporation

Correct option- c

Explanation: B corporation is majorly a part of the U.S. states.

5. Which corporation can be susceptible to tax exemption?

1. Non-profit corporation
2. LLC
3. S corporation
4. Close corporation

Correct option- a

Explanation: Non-profit corporations can be susceptible to tax exemption.

Related Concepts

• Formalize taxation methods
• LinkedIn
• Legal documentation
• Types of businesses