One of the most important decisions when starting a business is choosing the right legal structure. Your choice will affect how you run your business, engage in transactions, protect yourself from liability, and manage taxes.
Sole Proprietorship
A sole proprietorship is the most common and easiest type of business to form. It gives you complete managerial control but also makes you personally liable for all financial obligations. If your business carries significant liability risk, you should carefully weigh whether you can afford that exposure.
Partnership
A partnership involves two or more people sharing profits and losses. The key advantage is that income and losses pass through to partners’ individual tax returns, avoiding corporate taxation. The major drawback is liability: each partner is personally responsible for the business’s financial obligations.
Limited Liability Company (LLC)
An LLC combines the benefits of a partnership with liability protection. Owners can limit their personal risk while still enjoying pass-through taxation. LLCs may now be formed with a single member. A downside is self-employment tax: members must pay 15.3% of profits, compared to other structures where self-employment tax is only applied to salary, not full profits.
Corporation
A corporation is a separate legal entity and offers the strongest liability protection. However, it is also the most expensive and complex to form and maintain. One disadvantage is double taxation. For example, if a corporation earns $100,000 and distributes $10,000 in dividends to two owners, the corporation pays tax on its profits and each owner also pays tax on their dividends.
S Corporation
A corporation is a separate legal entity and offers the strongest liability protection. However, it is also the most expensive and complex to form and maintain. One disadvantage is double taxation. For example, if a corporation earns $100,000 and distributes $10,000 in dividends to two owners, the corporation pays tax on its profits and each owner also pays tax on their dividends.
How to Choose the Right Structure
When selecting a business structure, consider liability, tax implications, formation costs, ongoing administration, flexibility, and control. Since changing entities later can be difficult, making the right choice from the start is crucial.
At Smith Schafer, our professionals help Minnesota business owners evaluate the right structure to minimize taxes, reduce risk, and support long-term growth. Explore our Tax Services and Business Consulting Services to learn how we can guide your decision.
Frequently Asked Questions
What is the best business entity for small businesses in Minnesota?
It depends on your goals, liability exposure, and tax situation. Many small businesses choose LLCs for liability protection and tax flexibility.
What are the tax advantages of an LLC vs. an S Corporation?
LLCs provide flexibility but require self-employment taxes on all profits. S Corporations can reduce self-employment taxes but come with more restrictions.
Can I change my business entity later?
Yes, but it may be costly and complex. Consulting with an advisor before choosing your structure is highly recommended.
For more information about choosing the right business structure, contact a Smith Schafer professional. We look forward to helping you build a strong foundation for your business.
