The United States recognizes a handful of legal business structures, and the choice among them comes down to two questions: who is personally responsible when the business owes money or gets sued, and how is the income taxed? The common types of legal business structures are the sole proprietorship, the partnership (in general, limited, and limited liability forms), the limited liability company, the C corporation, and the S corporation. Each one answers those two questions differently, and the structure you pick shapes everything from your yearly tax bill to whether a creditor can reach your house.
Sole Proprietorship
A sole proprietorship is what you get by default. Start selling goods or services without filing anything with your state, and you are already running one. There is no legal line between you and the business. You own every asset, keep every dollar of profit, and owe every debt. If the business cannot pay a supplier or loses a lawsuit, creditors can pursue your personal bank accounts, your car, and your home.
All business income goes on Schedule C of your personal Form 1040.1Internal Revenue Service. About Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship) On top of regular income tax, you pay self-employment tax on net earnings at a combined rate of 15.3 percent, which covers both Social Security (12.4 percent) and Medicare (2.9 percent).2Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes) The Social Security portion applies only up to an annually adjusted wage base.3Social Security Administration. Contribution and Benefit Base
The appeal is simplicity. The cost is unlimited personal exposure.
General, Limited, and Limited Liability Partnerships
A partnership forms when two or more people agree to run a business together. There are three versions, and the liability picture is different in each.
In a general partnership, every partner shares management and shares personal exposure for the business’s debts. Each general partner acts as an agent for the business, so one partner can sign a contract that legally binds all the others.4Cornell Law Institute. General Partner A written partnership agreement is not legally required in most states, but operating without one invites disputes over profit splits and decision-making that are much harder to untangle later.
A limited partnership has at least one general partner who runs things and carries full personal liability, plus one or more limited partners who contribute capital, stay out of daily management, and can lose only what they invested. The structure suits investors who want a stake without the operational risk.
A limited liability partnership is common among attorneys, accountants, and architects. Partners are generally shielded from personal liability for the malpractice or negligence of their fellow partners. Most states require LLPs to carry specified insurance or meet minimum financial security thresholds.
Partnerships themselves do not pay federal income tax. The partnership files an informational Form 1065 and issues a Schedule K-1 to each partner, who reports their share of profit or loss on a personal return. General partners pay self-employment tax on their earnings.
Limited Liability Company
The LLC combines corporate-style liability protection with partnership-style tax flexibility, which is why it has become the default pick for most new small businesses. Owners are called members, and the LLC is its own legal entity. It can own property, sign contracts, and borrow money in its own name. If it gets sued or cannot pay its bills, members’ personal assets are generally protected.
You create one by filing Articles of Organization (sometimes called a Certificate of Formation) with your state and paying the filing fee, which varies by jurisdiction. The internal rulebook is the operating agreement, which spells out how profits are divided, how decisions get made, and what happens if a member leaves. Most states do not require you to file this document anywhere, but it becomes the key piece of evidence if members end up fighting.
Tax Flexibility
The IRS has no dedicated LLC tax category. By default, a single-member LLC is treated as a disregarded entity, meaning the owner reports everything on Schedule C the same way a sole proprietor would, and a multi-member LLC is taxed as a partnership.5Internal Revenue Service. Single Member Limited Liability Companies But any LLC can file Form 8832 to elect corporate tax treatment, or Form 2553 to be taxed as an S corporation.6Internal Revenue Service. About Form 8832, Entity Classification Election No other structure gives you that menu.
Management
An LLC can be member-managed, where all members share day-to-day decisions, or manager-managed, where authority is delegated to one or more designated managers while the other members take a passive role. Member management is the default in most states; if you want manager management, specify it in your formation documents or operating agreement.
Keeping the Liability Shield
LLC protection is not automatic and permanent. Courts can pierce the veil and hold members personally responsible if the LLC is being treated as a shell rather than a real separate entity. The fastest way to lose protection is commingling funds: depositing business revenue into a personal checking account, paying personal bills with a company card, or running business expenses through personal Venmo. Keep a dedicated business bank account, use it only for business, and document any loans between you and the LLC with a written note.
Most states do not require LLCs to hold formal annual meetings or keep written minutes, but you will typically need to file an annual or biennial report to stay in good standing. Miss that filing and the state can administratively dissolve the entity, which strips the liability protection entirely.
C Corporation
A C corporation is a fully independent legal entity with the most formal structure of any business type. Ownership is divided into shares of stock. Shareholders elect a board of directors to set strategy, and the board appoints officers to run daily operations. That separation of ownership from management is what makes corporations attractive for raising outside investment, since shareholders can buy and sell stakes without disrupting the business.
Double Taxation
The defining trade-off is double taxation. The corporation pays federal income tax on its profits at a flat 21 percent.7Office of the Law Revision Counsel. 26 USC 11 – Tax Imposed When the company distributes dividends, shareholders then pay personal income tax on that same money. The corporation files its own return on Form 1120 each year.8Internal Revenue Service. About Form 1120, U.S. Corporation Income Tax Return Some businesses soften the hit by paying owner-employees reasonable salaries (deductible to the corporation) rather than distributing dividends, but the IRS watches for unreasonable compensation used purely as a tax strategy.
Formalities
Corporations carry the heaviest administrative load. State corporate law generally requires annual shareholder meetings, regular board meetings, written minutes, and adoption of bylaws. These are not paperwork for its own sake. They are evidence that the corporation is operating as a genuine independent entity rather than as its owners’ alter ego. Skip them and plaintiffs get ammunition to pierce the corporate veil, the same concept that applies to LLCs. Adequate capitalization matters too: a corporation that never has enough cash to meet its own obligations looks like a shell, and courts treat it that way.
S Corporation
An S corporation is not a separate type of entity. It is a federal tax election that an existing corporation (or LLC) makes with the IRS. The election eliminates double taxation by letting business income, losses, deductions, and credits pass through to shareholders’ personal returns, while the underlying entity keeps its corporate liability protection.
Who Qualifies
Not every corporation can elect S status. Under 26 U.S.C. § 1361, the business must meet all of these:
- Be a domestic corporation organized in the United States.
- Have 100 or fewer shareholders; family members can be counted as a single shareholder.
- Have only eligible shareholders — individuals, certain trusts, or estates. Partnerships, other corporations, and nonresident aliens cannot hold shares.
- Have only one class of stock. Voting rights among common shares can differ, but all shares must have identical rights to distributions and liquidation proceeds.
To make the election, file Form 2553.10Internal Revenue Service. About Form 2553, Election by a Small Business Corporation It must be filed no later than two months and 15 days after the beginning of the tax year the election is to take effect, or at any time during the preceding tax year.11Internal Revenue Service. Instructions for Form 2553 Miss that window and the election waits until the following year.
How Pass-Through Taxation Works
Once the election is in place, the corporation generally pays no federal income tax. Profits and losses flow through to each shareholder’s personal return based on ownership percentage. Shareholders receive a Schedule K-1 reporting their share of income, deductions, and credits.12Internal Revenue Service. Shareholder’s Instructions for Schedule K-1 (Form 1120-S) The double-taxation problem goes away.
The Reasonable Compensation Rule
Distributions from an S corporation to shareholders are not subject to payroll taxes, which creates an obvious temptation: pay yourself a tiny salary and take the rest as distributions to dodge Social Security and Medicare. The IRS sees this constantly and pushes back. Any shareholder who performs more than minor services for the corporation must receive reasonable compensation as wages before taking distributions.13Internal Revenue Service. S Corporation Employees, Shareholders and Corporate Officers
“Reasonable” means what a comparable employer would pay someone with your experience for similar work. The IRS looks at your duties, the time you spend on the business, and what non-owner employees earn. If an audit reclassifies distributions as wages, you owe back payroll taxes plus penalties and interest.
Choosing Among Them
The practical sorting usually looks like this. If you are testing an idea alone and the business carries little risk of a lawsuit, a sole proprietorship costs nothing to start and may be enough. If you are going into business with other people and want flexibility over who manages and who just invests, a partnership form fits — with the general partner carrying the exposure. If you want personal asset protection without heavy formalities, the LLC covers most situations and gives you tax options later. If you plan to raise outside investment through stock, you need a corporation, and the C versus S choice turns on whether you can meet the S-corp eligibility rules and want pass-through taxation.
Getting an EIN
Whichever structure you pick, the IRS requires an Employer Identification Number for any partnership, LLC, or corporation, with or without employees.14Internal Revenue Service. Employer Identification Number Sole proprietors can use a personal Social Security number if they operate alone, but they need an EIN once they hire employees, file excise tax returns, or set up a retirement plan.15Internal Revenue Service. Get an Employer Identification Number If you are forming an LLC, partnership, or corporation, finish the state formation filing first — the EIN application asks for your entity type and formation date, and applying too early can cause delays. The application is free, is completed online at irs.gov, and the number is issued immediately on approval.