What Is Classification of Business According to Ownership?
Classification of business according to ownership describes the different business structures available for small business owners.3 min read
Classification of business according to ownership describes the different business structures available for small business owners. The most common types of business ownership structures are:
- Sole proprietorships
- General partnerships
- Limited partnerships
- C corporations
- S corporations
- Limited liability corporations (LLCs)
Sole proprietorships, owned by one person, are the most common small business type. The owner doesn't need to file any paperwork to begin running a sole proprietorship.
Sole proprietorships are easy to form and do not require any fees. Any business profits belong exclusively to the proprietor. The proprietor reports income and expenses to the Internal Revenue Service (IRS) on their personal tax return.
However, a sole proprietorship doesn't separate the business's assets from the owner's personal assets. Because a sole proprietorship has unlimited liability, there isn't any protection for the proprietor's personal assets if the business fails or loses a major lawsuit.
At least two people must contribute resources to form a general partnership. The partners must file the Articles of Partnership agreement with the state where they do business. This document defines the duties of each partner and how the partners will divide profits and losses.
General partnerships are easy to form. They only require that businesses file a partnership agreement and that the partners divide all profits among themselves. Each partner reports their share of income and expenses to the IRS on their personal tax return.
Like in a sole proprietorship, the partners' personal assets aren't separate from the business's assets. Because of unlimited liability, there isn't any protection for the partners' personal assets if the business fails or loses a major lawsuit.
A limited partnership is more complicated and costly to form. In a limited partnership, one person (general partner) seeks out partners (limited partners) to invest in the business. The general partner then runs the business's operations and handles any business debts, while the limited partners have minimal control over the business but also have no personal liability.
A C corporation is the most common type of organization and can have an unlimited number of shareholders. C corporations must register Articles of Incorporation with the state where they conduct business. There are also federal and local regulations they must follow.
A board of directors controls the business operations, and the shareholders have minimal involvement but also enjoy limited liability. Because a C corporation is independent of its shareholders, the shareholders' personal assets are protected from the business's creditors.
One disadvantage of a C corporation is that the corporation must pay taxes on its income and, if the corporation pays dividends to its shareholders, the shareholders must pay personal taxes on the dividends they receive. Some corporations offer options to avoid this double taxation, such as not paying dividends to shareholders or reducing the business's profit to zero.
Like a C corporation, an S corporation is managed by a board of directors, offers its shareholders limited liability, and must register Articles of Incorporation with the state where it conducts business. However, an S corporation is limited to 100 shareholders.
When filing taxes, an S corporation only pays taxes at the individual level and not at the corporate level. It avoids double taxation by passing all profits directly to shareholders, who then pay taxes on the income they receive.
Limited Liability Companies (LLCs)
Limited liability companies are owned by members who contribute resources to the business. LLCs are a popular choice because they offer members the limited liability of a corporation with the tax and management benefits of a partnership. LLCs must file Articles of Organization in the state where they do business.
An LLC does not require a board of directors and is less costly to maintain than a corporation. Because an LLC is a separate legal entity, independent of its members, the individual members are protected from personal liability.
An LLC is only taxed at the individual level and not at the corporate level. They avoid double taxation by passing all profits directly to shareholders, who then pay taxes on the income they receive.
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