Choosing a legal structure is one of the first real decisions a new business makes, and it shapes personal liability, taxation, paperwork, and the ability to bring in investors. Entity law is state law and tax treatment is largely federal, so the right answer depends on your state, your industry, and your plans. This is general information, not legal or tax advice.
Sole Proprietorship
A sole proprietorship is the default when one person does business without forming an entity. There is nothing to file beyond ordinary local licenses and, if you use a trade name, a "doing business as" registration.
Liability: there is no separation between you and the business. You are personally responsible for every business debt, contract, and judgment, and personal assets such as savings and, depending on state exemptions, your home may be exposed. Taxation: the business is not taxed separately. Income and expenses are reported on Schedule C of your personal return, and net earnings are subject to self-employment tax of 15.3 percent up to the Social Security wage base, plus Medicare above it.
General Partnership
A general partnership arises automatically when two or more people carry on a business for profit together, even without a written agreement. A written partnership agreement is still strongly advisable to define contributions, profit splits, decision-making, and exit terms.
Liability: each partner is personally liable for partnership obligations, and generally jointly and severally liable — a creditor may pursue any one partner for the full amount. Partners can also bind the partnership through their acts. Taxation: the partnership files an informational return (Form 1065) and issues each partner a Schedule K-1; profits flow through and are taxed on partners' personal returns, with active partners generally owing self-employment tax on their share.
Limited Liability Company (LLC)
The LLC is the most common choice for small businesses because it combines liability protection with flexible management and relatively light formalities. It is created by filing articles of organization with the state, and governed internally by an operating agreement.
Liability: members are generally not personally liable for the LLC's debts, provided the company is properly capitalized, keeps separate finances, and observes basic formalities — otherwise a court may "pierce the veil." Personal guarantees on loans and a member's own negligent acts remain personally binding. Taxation: an LLC is flexible. A single-member LLC is disregarded by default and reported on Schedule C; a multi-member LLC is taxed as a partnership by default; and an LLC may elect to be taxed as an S corporation or C corporation instead.
C Corporation
A C corporation is a separate legal entity formed by filing articles of incorporation, with a board of directors, officers, bylaws, issued stock, and required annual meetings and minutes. It is the standard structure for businesses seeking venture capital or planning an eventual public offering, because it can issue multiple classes of stock to unlimited shareholders, including foreign and entity investors.
Liability: shareholders are generally shielded from corporate debts, subject to the same veil-piercing and personal-guarantee caveats. Taxation: the corporation pays federal income tax on its profits at a flat 21 percent rate, and shareholders pay tax again on dividends they receive — the familiar "double taxation." Retained earnings reinvested in the business are not taxed a second time, and qualified small business stock can offer significant capital-gains benefits for founders and investors.
S Corporation
An S corporation is not a separate entity type but a federal tax election available to eligible corporations and LLCs. Eligibility is restricted: no more than 100 shareholders, all generally U.S. individuals or certain trusts, and only one class of stock.
Liability: identical to the underlying entity — corporate or LLC-level protection. Taxation: profits and losses pass through to owners' personal returns, avoiding entity-level federal tax. The main planning attraction is payroll treatment: an owner-employee must be paid reasonable compensation subject to employment taxes, while remaining distributions are not subject to self-employment tax. The trade-off is stricter payroll requirements, additional filings, and ownership limits.
Limited Partnership and Limited Liability Partnership
A limited partnership (LP) has at least one general partner who manages the business and bears personal liability, and limited partners who invest passively and risk only their contributions — losing that protection if they take part in management. LPs are common in real estate and investment funds.
A limited liability partnership (LLP) allows all partners to participate in management while shielding each from liability for other partners' malpractice or misconduct; many states restrict LLPs to licensed professionals such as attorneys, accountants, and architects. Both are pass-through entities for tax purposes, reported on partner K-1s.
Factors to Weigh
In practice, the decision usually turns on a handful of questions:
- Liability exposure: how likely is the business to face claims, and how much personal wealth is at risk?
- Tax profile: expected profit level, whether earnings will be distributed or reinvested, and self-employment tax exposure.
- Ownership and investment: how many owners, whether outside investors are planned, and whether different classes of ownership are needed.
- Administrative burden: state filing fees, annual reports, franchise taxes, payroll requirements, and recordkeeping you can realistically maintain.
- State-specific rules: formation costs and annual franchise taxes vary widely, and professional practices often face additional restrictions.
- Flexibility later: converting from an LLC to a corporation is common and manageable; unwinding a corporation can be more costly.
Because entity choice interacts with tax planning, licensing, and contracts, most owners benefit from a short conversation with a business attorney and a CPA before filing. A free case review can connect you with an independent attorney who handles business formation matters.