Understanding the Basics of Business Structures

By Adil Daudi, Esq.

Recently, I was approached by a client who was interested in starting a business, however he was curious to learn about the different business structures available, and which would be most suitable for him. Considering this was not the first time I have addressed such an inquiry, I felt it prudent to elaborate on the various structures and explain the differences between each.

Please be aware that this is not a comprehensive description of the structures and it is always advised to speak to an attorney who would better be able to provide sound advice on which structure is most suitable for your particular needs, expectations and business.

One of the most common misconceptions when it comes to creating a business is that many feel that an incorporation is automatically the best structure to use; however, that is not always true. In order to fully understand why, or why not, an incorporation is most applicable, it is important to get a basic understanding of the other available business entities.  

In Michigan, there are three common business structures that owners can typically choose from: Partnership/Sole Proprietorship, Corporation, and Limited Liability Company.

1. Partnership/Sole Proprietorship: The major difference between a partnership and a sole proprietorship is in the number of owners. In a sole proprietorship, there is essentially only one owner; hence the word “sole.” On the other hand, in a partnership, it is comprised of two or more owners who come together with the intent of advancing their mutual interest.

Depending on the specific type of business you are operating, creating a sole proprietorship or a partnership is not always recommended. Under either of these structures, you, the business owner, are responsible for all taxes. However, the method in how you file your taxes does not differ from your current procedure, as the income received by your company would simply be inputted in your personal tax returns.

However, probably the biggest drawback with a sole proprietorship and partnership is that in the event your company is involved in any legal action, you are ultimately responsible for any and all judgments, whereby your business assets and your personal assets can be seized to satisfy any judgment. 

2. Corporation/Limited Liability Company (LLC): One of the biggest benefits of setting up a corporation or an LLC is that it reduces the exposure of the owners and their assets in the event of a legal action. Because corporations and LLC’s are considered separate entities, requiring a separate tax ID number, a separate tax return, the only assets that can be seized for judgment are the assets owned by the corporation/LLC; therefore, the owners are not held personally liable, and thus have their assets safeguarded from potential liability.

With respect to the taxes, the profit obtained by a corporation/LLC is taxed to the company when earned, and if the shareholder (under a corporation) decides to distribute dividends, the shareholder would also be taxed individually. Thus, this creates a double tax, which is not always appealing. This double taxation can be avoided through the use of an LLC, where there are no shareholders, but rather members to the company. Please speak to an expert for further information in how to reduce your taxes through the set-up on an LLC.

As indicated above, it is always best to rely on the expert opinion of an experienced attorney who would be able to discuss in more depth the differences between each respective structure and determine, based on your specific needs, which structure is most efficient for you. Although starting a partnership/sole proprietorship is the easier and cheaper selection, it may not always be the most optimum, as you could be opening yourself up to unnecessary liability.

Adil Daudi is an Attorney at Joseph, Kroll & Yagalla, P.C., focusing primarily on Asset Protection for Physicians, Physician Contracts, Estate Planning, Business Litigation, Corporate Formations, and Family Law. He can be contacted for any questions related to this article or other areas of law at adil@josephlaw.net or (517) 381-2663.

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