How do I decide what structure my business should be?

Two decisions wearing one coat

People asking this question are usually asking two at the same time. What should the business be, legally? And how should it be taxed? Those are related and they are not the same decision, which is why the answer is so often a combination rather than one of the options as listed.

This page is about the wider decision: what each form does about liability, about who can own part of it, about what happens when somebody wants out. The narrower arithmetic — whether a particular election beats what it costs to run at your level of profit — is its own question and it belongs in a conversation with your own figures in front of you.

What each one is

Sole proprietorship

The default when one person trades without registering anything. Simplest to run and offers no separation: personal assets sit behind the obligations of the business. Income lands on the personal return and carries self-employment tax on the profit.

Single-member LLC

Puts a boundary between you and the obligations of the business while keeping the tax treatment simple. By default it is taxed as though you and it were the same person, which means self-employment tax still applies to the profit. A common and sensible starting point.

Multi-member LLC

The same protection with more than one owner. Taxed as a partnership by default, with income and losses allocated the way the operating agreement says — which makes that agreement the most important document in the business.

The S-Corp election

Not an entity at all: a tax election an eligible LLC or corporation makes. It splits money coming out into a salary, which carries payroll tax, and distributions, which do not. It brings payroll for yourself, more bookkeeping and formalities that have to actually be kept, and it restricts who is allowed to own part of the business.

C-Corporation

A fully separate taxpayer. It pays tax itself, and shareholders are taxed again when money is distributed to them. That matters less than it sounds when the business is raising outside money, has a complicated ownership picture, or intends to sell shares. For most small businesses it is not the answer.

What the decision actually turns on

Four questions do most of the work, and none of them are answerable from a web page.

What the profit is now and where it is heading, because the balance between what a structure saves and what it costs to run moves with that number. What role you actually play — an owner who does the work and an owner who owns it are in different positions. Whether anyone else owns part of it now, or might. And how it ends: sale, family, wind-down, or nothing planned yet, which is itself an answer.

Ask anybody advising you to show the comparison rather than name the answer. The arithmetic is not complicated. It just has to be done with your figures instead of somebody else's rule of thumb.

The state layer

Federal is only half of it, and the state half is the one that surprises people.

In Rhode Island a registered entity generally owes a minimum amount at state level whether or not it earned anything, which is why a company someone stopped using but never closed keeps accruing quietly. If you have a dormant entity sitting out there, mention it — that is usually worth cleaning up rather than leaving alone.

There is also an annual filing: a short return that every registered entity in Rhode Island makes once a year, inside a fixed window early in the year, to stay in good standing. Miss it and a penalty follows; keep missing it and the entity's standing is at risk. It is one of the easiest things to forget and one of the simplest to put right.

It is not decided once

The structure that was right when the business started is not automatically right now, and nothing prompts you to check. A business that has grown is worth re-examining rather than assuming.

A partner arriving means the operating agreement and possibly the tax treatment both need looking at. Outside investment often means restructuring to something an investor can actually buy into. And a business whose profit has changed shape may have crossed the line where a different treatment starts to pay for itself.

The right answer at one size is not automatically the right answer at twice it.

Before the filing, not after

Filing the paperwork is the easy part. Choosing what to form and how it will be taxed is the part worth thinking about, because changing it later means unpicking bank accounts, payroll and sometimes a tax identification number. Start that conversation before the filing rather than after it.

The same applies to the tax identification number itself. Some changes — a change of entity type in particular — call for a new one rather than carrying the old one across, and that is much easier to establish beforehand than to discover afterwards.