Choosing among business legal structures comes down to five options — sole proprietorship, general or limited partnership, limited liability company, corporation (taxed as a C corp or S corp), and nonprofit corporation — and the right one depends on how much personal liability you can accept, how you want the business taxed, and how much paperwork you are willing to maintain. The structure you pick decides who pays when the business is sued, how profits move onto your tax return, and what you have to file every year to stay in good standing.
Sole Proprietorship
A sole proprietorship is what you have by default the moment you start doing business on your own without filing anything with the state. There is no legal line between you and the business. Every dollar it earns is yours; every debt and lawsuit it faces is also yours. A creditor with a judgment can reach your personal bank account, your car, and your home.
All profits flow onto your personal return using Schedule C.1Internal Revenue Service. About Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship) On top of regular income tax, you owe self-employment tax at 15.3 percent of net earnings, which covers both the employer and employee shares of Social Security and Medicare.2Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes) That is harder than it sounds, because a W-2 employee only sees 7.65 percent come out of their paycheck while the employer quietly pays the rest.
If you want to operate under a name other than your own legal name, most states require you to register a fictitious business name, often called a DBA (doing business as). A DBA does not create a separate entity and gives you no liability protection. It just puts your real name on record so customers and creditors know who they are dealing with.
Because the business is legally you, it ends when you stop operating or die. Sole proprietorships work for freelancers and very small operations, but the unlimited personal liability becomes a real problem the moment you hire anyone, sign a lease, or take on any meaningful financial risk.
Partnerships
Two or more people doing business together without filing formation documents have a general partnership by default. Any partner can sign contracts that bind the whole business, and every partner is personally liable for all of the partnership’s debts. One partner’s bad decision can expose every other partner’s personal assets. You are not just answerable for your own mistakes — you answer for your partners’ mistakes too.
Limited Partnerships
A limited partnership splits participants into two groups. General partners run the business and carry unlimited personal liability. Limited partners put in money, stay out of day-to-day management, and have their liability capped at what they invested. The catch matters: if a limited partner starts making management decisions, courts can strip the cap and treat them as a general partner.
Limited Liability Partnerships
Professionals like lawyers, accountants, and doctors often use a limited liability partnership. The key feature is that one partner is not personally liable for another partner’s professional malpractice or negligence. You still answer for your own work and for ordinary business debts, but your personal assets are shielded from claims arising out of a colleague’s errors. Not all states allow LLPs for every profession, so availability depends on where you practice.
All partnership types share one tax feature: the partnership itself does not pay federal income tax. Profits and losses pass through to each partner’s personal return according to the partnership agreement, and partners pay self-employment tax on their share.
Limited Liability Company
The LLC is the most popular structure for new small businesses because it pairs personal liability protection with flexible tax treatment. Owners are called members, and the business comes into existence when you file formation documents (usually articles of organization or a certificate of organization) with the state.3Internal Revenue Service. Limited Liability Company (LLC) Filing fees vary by state, and some states charge an annual or biennial fee to keep the LLC in good standing.
How an LLC Is Taxed
The IRS does not have its own LLC tax category. It assigns a default classification by the number of members. A single-member LLC is treated as a disregarded entity and files on Schedule C, exactly like a sole proprietorship. A multi-member LLC is taxed as a partnership by default.4Internal Revenue Service. Single Member Limited Liability Companies In both cases, profits pass through to the members’ personal returns, and the LLC itself owes no federal entity-level tax.
You can also file Form 8832 to elect corporate tax treatment, or go further and elect S corporation status.5Internal Revenue Service. Limited Liability Company – Possible Repercussions That flexibility lets you pick the tax treatment that fits without changing your underlying legal structure. Once you make an election, though, you generally cannot switch again for 60 months.
Keeping Your Liability Shield
LLC liability protection is not automatic. Courts can pierce the veil and hold members personally responsible when the LLC is being used as a personal piggy bank rather than a real separate business. The behaviors that cost members their protection are predictable: mixing personal and business money in the same account, failing to keep basic records, using the LLC to commit fraud, or running the business so informally that nobody can tell where the member ends and the company begins. A separate business bank account, written documentation of major decisions, and clean financial separation are the practical requirements for keeping the shield intact.
C Corporations and S Corporations
A corporation is a fully independent legal entity, separate from the people who own it, manage it, and work for it. It can own property, enter contracts, sue, and be sued in its own name. Shareholders own the company, a board of directors sets strategy, and officers run daily operations. That layered governance adds cost and complexity, but it also puts the strongest wall between the business and its owners.
C Corporations
The default corporate tax treatment is the C corporation, named for Subchapter C of the Internal Revenue Code. A C corporation pays federal income tax on its own profits at a flat 21 percent rate.6Internal Revenue Service. S Corporations When the corporation later distributes those after-tax profits to shareholders as dividends, the shareholders pay tax again on their personal returns. This double taxation is the most frequently cited downside of the C corp structure.
C corporations are still the standard choice for businesses that plan to raise outside investment, issue multiple classes of stock, or eventually go public. Venture capital firms and institutional investors typically require a C corporation because the structure accommodates preferred stock, complex equity arrangements, and an unlimited number of shareholders of any type. Qualified small business stock treatment under Section 1202 of the Internal Revenue Code also offers a sizable capital gains exclusion on shares held long enough, subject to industry and asset-size limits that exclude most service businesses.
S Corporations
An S corporation is not a separate type of entity. It is a tax election that an eligible corporation (or LLC) makes by filing Form 2553 with the IRS. The election causes the corporation’s income, losses, and deductions to pass through to shareholders’ personal returns, avoiding double taxation.6Internal Revenue Service. S Corporations
Eligibility is strict. The business must be a domestic corporation with no more than 100 shareholders, only one class of stock, and no shareholders that are partnerships, other corporations, or nonresident aliens.7Office of the Law Revision Counsel. 26 USC 1361 – S Corporation Defined Spouses and family members can count as a single shareholder toward the 100-shareholder cap, which gives family businesses some breathing room.
The real tax draw of an S corp is the ability to split income between salary and distributions. Only the salary portion is subject to Social Security and Medicare taxes; distributions are not. But the IRS watches this closely. Before taking any distributions, shareholder-employees must pay themselves a reasonable salary comparable to what someone else would earn for the same work.8Internal Revenue Service. S Corporation Compensation and Medical Insurance Issues Paying yourself an unreasonably low salary and taking the rest as distributions is one of the fastest ways to trigger an audit. The IRS can reclassify distributions as wages and assess back employment taxes plus penalties.
Corporate Formalities
Regardless of tax election, every corporation has to follow formal governance procedures to keep its legal standing. That means drafting bylaws, holding annual meetings of shareholders and directors, keeping written minutes of those meetings, and documenting major decisions. Skipping these formalities does more than risk fines. It gives opposing lawyers ammunition to argue that the corporation is a sham and that shareholders should be held personally liable.
Nonprofit Corporations
A nonprofit corporation is organized to serve a charitable, educational, religious, or similar public-benefit purpose rather than to make money for owners. Any surplus revenue has to be reinvested into the mission. It cannot be distributed to directors, officers, or other insiders. Federal law treats even a small amount of private benefit flowing to insiders as grounds for revoking tax-exempt status.9Internal Revenue Service. Exemption Requirements – 501(c)(3) Organizations
Most nonprofits apply for recognition of tax-exempt status under Section 501(c)(3).10Internal Revenue Service. Applying for Tax Exempt Status Once approved, the organization is exempt from federal income tax on mission-related activities, and donors can deduct their contributions. Board members take on a fiduciary duty to keep the organization focused on its stated purpose and to manage its finances responsibly.
Tax-exempt status does not mean a nonprofit never owes tax. Income from activities unrelated to the exempt purpose — selling advertising in a newsletter, renting facilities for unrelated events, running a retail store with no connection to the mission — is subject to unrelated business income tax. If total gross income from unrelated activities reaches $1,000 or more, the nonprofit has to file Form 990-T and pay tax on that income.11Internal Revenue Service. Publication 598, Tax on Unrelated Business Income of Exempt Organizations Most tax-exempt organizations also have to file Form 990 annually, and late-filing penalties accrue daily until the return is filed, with higher daily rates for larger organizations.12Internal Revenue Service. Annual Exempt Organization Return – Penalties for Failure to File
How to Choose
The right structure depends on how much personal risk you can accept, how you want to be taxed, and where you see the business going. The practical tradeoffs break down along four lines.
Liability. If you are the only owner and the business carries little risk of being sued (freelance writing, consulting from home), a sole proprietorship can work. The moment you take on employees, sign a commercial lease, or sell a physical product, unlimited personal liability becomes a serious problem. An LLC or corporation puts a legal wall between the business and your personal assets.
Taxes. Sole proprietorships and partnerships are the simplest, but you pay self-employment tax on all net earnings. An S corporation election can reduce that bill by splitting income between salary and distributions, but only once the business earns enough to justify the added payroll and compliance costs. C corporations make sense when you need outside investors or plan to reinvest most profits rather than distribute them.
Raising money. A C corporation offers the most flexibility for bringing in investors. S corporations are capped at 100 shareholders with strict eligibility rules. LLCs can take on new members, but operating agreements get complicated, and some institutional investors will not invest in an LLC.
Cost and complexity. A sole proprietorship has almost no setup or maintenance cost. An LLC requires formation filings and annual fees. A corporation adds mandatory governance on top: bylaws, board meetings, minutes. Skip the formalities and you risk losing liability protection entirely.
For most small businesses with real liability exposure, an LLC taxed under its default classification is the practical middle ground. It gives you a shield without forcing you into corporate governance, and you can elect S corp or C corp tax treatment later if your situation changes.
Changing Structure Later
You are not locked in. Sole proprietors who outgrow their structure commonly convert to an LLC by filing formation documents with the state, getting a new EIN from the IRS, opening a separate business bank account, and updating licenses, permits, and contracts. A single-member LLC taxed as a disregarded entity still files on Schedule C, so day-to-day tax treatment may not change, but the liability protection does.
An LLC can later elect to be taxed as an S corp or C corp by filing the right form with the IRS, without changing the underlying legal entity at the state level.5Internal Revenue Service. Limited Liability Company – Possible Repercussions Going the other direction, from a corporation back to an LLC, is more involved and can trigger tax consequences, so it is worth getting professional advice first. The general rule: moving from simpler to more complex is straightforward, and moving backward is harder and more expensive.
Federal and State Filings You Cannot Skip
Employer Identification Number
Partnerships, LLCs, corporations, and nonprofits all need an EIN from the IRS. Sole proprietors can use their Social Security number, but have to get an EIN once they hire employees, file excise tax returns, or withhold taxes on payments to nonresident aliens.13Internal Revenue Service. Employer Identification Number Applying is free and can be done online through the IRS website, with the number issued immediately. Change your structure and you generally need a new EIN for the new entity.
Beneficial Ownership Reporting
The Corporate Transparency Act originally required most small businesses formed in the United States to report their beneficial owners to the Financial Crimes Enforcement Network. As of March 26, 2025, all domestically created entities are exempt from this requirement. Only foreign entities that have registered to do business in a U.S. state or tribal jurisdiction still have to file beneficial ownership reports, and they must do so within 30 calendar days of receiving notice that their registration is effective.14FinCEN.gov. Beneficial Ownership Information Reporting U.S. persons are also exempt from providing their information as beneficial owners of any reporting company. The rules have shifted before and could shift again, so check FinCEN’s website if you are forming a new entity.
Registered Agents and Annual Reports
Every state requires LLCs and corporations to designate a registered agent, a person or company with a physical address in the state who accepts legal documents and government notices on behalf of the business. You can serve as your own, but many owners hire a service to keep a home address off public records and to make sure someone is always available during business hours to accept service of process. Beyond that, most states require annual or biennial reports and charge a filing fee to keep the entity in good standing. Miss them and the state can administratively dissolve your entity, which strips your liability protection until you reinstate.