Understanding Business Structures
Choosing the right business structure is one of the most important decisions for new business owners. Each type of business structure has unique features and benefits, and the structure you select will affect your company’s taxes, liability, and ability to grow.
How to Decide on a Business Structure
If you’re considering how to structure your business, you should start by identifying your goals and priorities. For example, consider whether you most want to limit your personal liability, simplify tax filing, or attract investors. You should also think about how many people will own the business and the level of control you want.
Each business structure also comes with legal and financial implications to consider. A sole proprietorship offers simplicity but does not protect personal assets. An LLC provides liability protection but involves more paperwork. Corporations make it possible to attract investors but require strict compliance with regulations.
The best way to decide on a structure is to consult a business formation lawyer. They can explain the pros and cons of each option to help you align your choice with your goals.
What Business Entity Is Best for a Small Business?
For small businesses in Pennsylvania, the choice of business structure often depends on several key factors including liability concerns, tax implications, and operational complexity. LLCs are a great choice for small businesses due to their blend of benefits. They protect personal assets from business liabilities while avoiding the complex corporate formalities and double taxation issues of traditional corporations. LLCs offer flexibility in how they’re taxed, allowing owners to choose between being taxed as a sole proprietorship, partnership, or corporation.
However, sole proprietorships might be more suitable for very small, low-risk businesses with minimal assets and liabilities, particularly when owners want to test their business concept before committing to a more formal structure. S-corporations can benefit profitable small businesses looking to minimize self-employment taxes, though they have more stringent operational requirements and ownership restrictions. Before deciding on a structure for your small business, it is recommended that you consult with both a business lawyer and tax professionals.
Types of Business Entities
In Pennsylvania, businesses can be structured in several common legal forms.
Sole Proprietorships
A sole proprietorship is the simplest business structure. As a sole proprietor, you own and operate the business yourself, and there is no legal distinction between you and your business. This simplicity makes it a popular choice for freelancers, consultants, and small businesses.
In a sole proprietorship, you report business income and expenses on your personal tax return. This pass-through taxation means you pay income taxes as an individual and don’t have to worry about separate business tax filings. However, as the sole owner, you are personally responsible for all debts and liabilities. This means creditors can go after your personal assets if your business cannot pay its debts.
Sole proprietorships require minimal setup and paperwork. Most states, including Pennsylvania, do not require formal registration unless you use a trade name, in which case you might need a “doing business as” (DBA) registration. Despite the ease of setup, this structure might not be ideal if you want to limit your personal liability or attract investors.
Partnerships
A partnership involves two or more people who share ownership of a business. Partnerships fall into two main categories: general partnerships and limited partnerships.
In a general partnership, all partners share management responsibilities and are personally liable for the business’s debts. This means creditors can pursue the personal assets of any partner to cover business obligations. General partnerships do not require formal registration in many states, meaning they’re easy to set up.
A limited partnership has at least one general partner who manages the business and assumes personal liability. Limited partners invest in the business but do not participate in management. Their liability is limited to their investment. Limited partnerships often appeal to businesses that need outside investors.
Both types of partnerships use pass-through taxation, so profits and losses flow through to the partners’ personal tax returns. This can simplify tax reporting but can also complicate individual tax obligations if the partnership earns significant income.
Limited Liability Companies (LLCs)
An LLC combines the benefits of a partnership and a corporation. It provides limited liability for its owners (called members) while offering the tax flexibility of a partnership. Members are not personally responsible for the business’s debts and liabilities, so their personal assets are protected in most cases.
LLCs also allow for pass-through taxation, where profits and losses pass through to members’ personal tax returns. An LLC can also choose to be taxed as a corporation, depending on what works best for the owners. This flexibility makes LLCs a popular choice for small businesses.
Setting up an LLC requires registration with the state, which includes filing articles of organization and paying a filing fee. LLCs offer more credibility than sole proprietorships or partnerships, which can be helpful when seeking loans or working with vendors.
Corporations
A corporation is a legal entity that is entirely separate from its owners. This structure provides the strongest protection against personal liability. Shareholders own the corporation, and a board of directors oversees its management. Corporations are ideal for businesses that plan to raise significant capital or eventually go public.
Corporations are subject to corporate taxation, which can result in double taxation. The business pays taxes on its profits, and shareholders pay taxes on any dividends they receive. However, S-corporations avoid double taxation by allowing profits and losses to pass through to shareholders’ personal tax returns, similar to how LLCs and partnerships operate.
Corporations require more paperwork and costs than other structures. You must file articles of incorporation, create corporate bylaws, and hold regular board meetings. Corporations face more regulations but benefit from their ability to attract investors and grow quickly.
Non-Profit Corporations
A non-profit corporation operates to achieve a specific mission rather than generate profit for owners or shareholders. These organizations typically focus on charitable, educational, religious, or scientific purposes. Non-profits must meet state incorporation requirements and apply for tax-exempt status with the IRS, usually under Section 501(c)(3).
Non-profit corporations enjoy several benefits, including exemption from federal income taxes and eligibility for grants and donations. However, they must follow strict regulations, including limits on political activities and requirements to reinvest earnings into their mission.
Legal and Tax Considerations
Each business structure presents distinct advantages and challenges when it comes to taxation and liability, which directly impact how you operate and protect your business.
From a liability perspective, sole proprietorships and general partnerships offer the least protection. Business debts and legal obligations become the personal responsibility of sole proprietors and general partners, so personal assets are exposed to potential risks. By contrast, LLCs provide limited liability by separating personal assets from business liabilities. This distinction makes them preferred choices for owners seeking to minimize personal risk. Corporations offer the strongest liability protection because these businesses exist as separate legal entities, so shareholders risk only their investments.
Tax considerations also vary significantly by structure. Sole proprietorships, partnerships, and LLCs typically use pass-through taxation, where profits and losses pass directly to the owners’ personal tax returns. This approach prevents double taxation but can increase the complexity of individual tax filings. Corporations are subject to corporate taxation, meaning the business pays taxes on profits, and shareholders pay taxes on dividends. However, S-corporations offer an alternative by allowing pass-through taxation while retaining corporate benefits.
Choosing the right structure involves weighing your risk tolerance, tax obligations, and plans for growth. A business formation lawyer can help you make the ideal decision for your needs.
Pennsylvania-Specific Requirements
If you’re starting a business in Pennsylvania, you must meet several state-specific requirements to ensure your business can operate legally and avoid fines or penalties.
State Taxes
Pennsylvania imposes state taxes on most businesses. Sole proprietors and partnerships report income on their personal tax returns and may pay personal income tax. LLCs can choose pass-through taxation or corporate taxation. Corporations pay Pennsylvania’s corporate net income tax, which applies to taxable income.
All businesses that sell goods or services subject to sales tax must register for a sales tax license and collect and remit sales tax to the Pennsylvania Department of Revenue. Employers must also handle payroll taxes, including withholding state income tax from employees’ wages.
Local Regulations
Pennsylvania businesses must comply with various regulations based on their structure and industry. Corporate entities, such as LLCs and corporations, must follow the Pennsylvania Business Corporation Law (BCL). This law addresses corporate governance, including filing requirements, fiduciary duties of directors, and rules for mergers or dissolutions.
Certain industries in Pennsylvania have additional regulatory requirements. For example, restaurants and food service businesses must comply with health and safety standards set by the Pennsylvania Department of Agriculture.
State labor laws also apply to most businesses. Employers must follow the Pennsylvania Minimum Wage Act, which establishes wage and overtime requirements. Businesses must also comply with workplace safety standards enforced by the Pennsylvania Department of Labor and Industry.
Additionally, Pennsylvania enforces environmental regulations for businesses that impact natural resources. These include permits for air emissions, water discharge, and waste disposal through the Pennsylvania Department of Environmental Protection.
Business Name Registrations
If your business operates under a name other than your legal name, you must register a fictitious name, also known as a “doing business as” (DBA) name. You file this with the Pennsylvania Department of State by submitting the Registration of Fictitious Name form and paying a $70 fee. You must also publish notice of the name in two newspapers in the county where your business operates.
How to Get a Business License in Pennsylvania
Pennsylvania does not require a general state business license, but some businesses need specific licenses or permits. Some local municipalities, such as cities or counties, require general business licenses or additional permits for certain activities.
Industry-specific licenses are also common. For example, restaurants need health permits, and contractors must register under the Home Improvement Consumer Protection Act. To determine your requirements, check with the Pennsylvania Licensing System (PALS) and your local government office.
Getting Started
Starting a business involves several important steps to ensure your company can operate legally and efficiently. You’ll need to prepare formation documents, obtain an EIN, and identify compliance requirements to get your business on the right path.
Preparing Formation Documents
Formation documents establish your business with the state. Corporations file articles of incorporation, which detail the company’s name, purpose, and ownership structure. LLCs submit articles of organization, which include similar information. Partnerships can draft partnership agreements, while sole proprietors can file fictitious name registrations if they operate under names other than their own. An attorney can help you determine which types of documents your business requires and prepare them on your behalf.
Federal Employer Identification Numbers (FEINs or EINs)
Many businesses need employer identification numbers (EINs) from the IRS. These unique numbers identify businesses for tax purposes. You need an EIN if you hire employees, operate as a corporation or partnership, or meet other IRS criteria. You can apply for an EIN online through the IRS website at no cost.
Annual Compliance
After forming your business, you must keep it compliant. Corporations and LLCs must file annual reports with the Pennsylvania Department of State to update ownership or address changes. Depending on your business, you might also need to renew licenses, maintain tax filings, and keep accurate records per Pennsylvania law. An attorney can help you stay on top of these tasks and ensure your business remains in good standing.
Why Seek Legal Advice?
If you’re forming a business, a business formation lawyer can help you make informed decisions about your structure, compliance, and long-term goals. They can also explain the advantages and disadvantages of each business structure, such as liability protection, tax implications, and operational requirements. They will also handle the process of preparing your formation documents to ensure accuracy and compliance with Pennsylvania laws.
Legal advice can help you identify potential issues early, such as licensing requirements, zoning restrictions, or intellectual property protections. Attorneys can also assist with drafting agreements, like operating agreements or partnership agreements, which formally outline responsibilities and reduce the risk of disputes.
Contact Our Pittsburgh Business Formation Attorneys
The choices you make now can shape the success of your business. Whether you need help forming an LLC, filing articles of incorporation, or drafting an operating agreement, Jones, Gregg, Creehan & Gerace can guide you every step of the way. Contact our team today for an initial consultation and get the guidance you need to move forward with confidence.
