When you’re starting a business, you have more than just your product and service offerings to consider. You should also choose a type of business operation that optimizes taxation and liability benefits. Additionally, your choice of business operation type should allow for an appropriate number of company owners and properly suit your industry. That said, your business type typically has minimal bearing on your business operation type.
The three major types of businesses are:
Some companies don’t provide services, manufactured products, or resold products solely. These companies are hybrid businesses. A great example is a vehicle manufacturer that both sells cars (its own products) and maintains an in-house staff for repairs (its services).
Any of the four business types described above can fall into one of the seven main types of business operations. These types of business operations are:
In a sole proprietorship, there is no legal or tax-related distinction between the business owner and the business itself. A sole proprietorship is the most common type of business operation for independent contractors. Sole proprietors can often use their personal taxpayer identification number (TIN), which is usually their social security number, for all taxation purposes.
In a partnership, all company owners divide their business obligations. Some partnerships are limited, meaning one partner has unlimited liability in legal matters and more overall power than other partners, who have limited liability and contribute far less to key business decisions. Others are limited-liability, meaning each partner’s liability is at most the amount of money they invest in the company. Limited and limited-liability partnerships are more common when investors are involved.
Partnerships are most common among professional groups such as law firms (that’s partially why law firm owners often call themselves “partners”) and people who want to test a new business idea before formally establishing a company. As with sole proprietorships, the owners’ business income is taxed as personal income (this is called pass-through taxation).
A corporation is an independent business entity with multiple shareholders. The two primary types of corporations are C corporations and S corporations, and the rules and requirements for each type differ.
You may want to make your company a corporation if it’s a medium- or high-risk entity. C corporations are especially useful for raising investor money or going public, whereas S corporation owners (of which there may be at most 100) may enjoy taxation benefits unavailable to C corporation owners.
You can learn more about S corporation and C corporation taxation, shareholder, and operational requirements via the SmartBiz Loans blog’s in-depth guide to S corporations and C corporations.
A limited liability company is a hybrid of a partnership and a corporation. As with a corporation, you’ll get legal protection for your personal assets. And since the IRS taxes multi-member LLCs as partnerships and single-member LLCs as sole proprietorships, you’ll get the pass-through taxation benefits of a partnership.
LLCs, like corporations, are typically medium- or high-risk companies. Their owners may also seek to avoid C corporation double taxation or have extensive personal assets they need to protect from legal action.
A nonprofit organization is a company that funnels all its earnings toward promoting a cause and covering the administrative expenses related to the company. In some cases, since a nonprofit organization by definition retains no earnings, these companies may apply for tax-exempt status. Many household-name humanitarian and social justice organizations are tax-exempt nonprofits.
Cooperative companies, also known as co-ops, are fully owned by all the people who use their products and services. Co-ops sell shares to members who share all company earnings, receive limited liability, and must play a part in the company’s operations. They are taxed as C corporations.
Of the approximately 5.6 million employers in the U.S., just over 1% are co-ops. The most common form of co-ops in the U.S. are grocery stores in which only members, who buy shares and contribute to store tasks, can shop.
| Type of business operation | Pass-through taxation | Personal liability | Number of owners | Best for |
|---|---|---|---|---|
| Sole proprietorship | Yes | Unlimited | One | Independent contractors |
| Corporation | Yes for S corporations No for C corporations | None | One or more, though at most 100 for S corporations | Medium- or high-risk entities; Business owners seeking investor money (C corporations); Business owners looking to avoid double taxation (S corporations) |
| LLC | Yes, unless you register your LLC as a C corporation | None | One or more | Medium- or high-risk entities; Business owners looking to protect their assets; Business owners looking to avoid double taxation |
| Nonprofit | May be entirely tax-exempt | None | One or more | Companies that use all their earnings to cover expenses and promote causes |
| Co-op | No | Limited | Two or more, though usually dozens to hundreds | Companies that want all members to equally share profits, expenses, and revenue, such as grocery store co-ops |
The above breakdown of the types of business organizations discusses only federal rules. Individual states may have other provisions you should consider as well, potentially including permitted funding routes. Check with the appropriate state authorities for clarification.