So, you’re ready to launch your dream business in Massachusetts? That’s great! But one of the first and most important decisions you’ll need to make is choosing the right business structure for your Massachusetts business. The business structure impacts everything from the taxes you pay, whether your personal assets are at risk, the potential for raising capital from outside investors, and your ongoing record-keeping requirements.
As a business formation attorney, I’ve helped countless entrepreneurs with choosing the right business structure in Massachusetts. This blog post discusses 5 common business structures in Massachusetts and what to consider when choosing the right business structure for your business.
Why Does Your Business Structure Matter?
Before we delve into the specifics, let’s underscore why this decision isn’t just a formality. Your chosen business structure in Massachusetts has significant implications for several key areas:
- Liability: This is a big one. Different business structures offer varying levels of protection for your personal assets (like your house, car, savings, etc.) from business debts and liabilities. Some business structures create legal separation between your and your business, while others don’t.
- Taxation: How your business is taxed significantly impacts your bottom line. For some business structures the profits and losses are only reported on your individual tax returns, while others are taxed separately as business entities. When choosing a business structure in Massachusetts, understanding these differences is crucial for effective financial planning.
- Administrative Burden: Some business structures are simpler to set up and maintain than others. Consider the ongoing paperwork, compliance requirements, and reporting obligations associated with each option when choosing a business structure for your Massachusetts business.
- Funding and Investment: Certain business structures are more attractive to outside investors than others. If you anticipate seeking outside funding, this will be a critical factor and may dictate the type of business structure you choose for your Massachusetts business.
- Management and Ownership: The business structure you choose may dictate the number of owners you have and how your business will be managed. Others are more flexible and do not set restrictions.
Understanding 5 Common Business Structures in Massachusetts
Here are 5 common business structures in Massachusetts and what you need to consider for each in connection with choosing a business structure for your Massachusetts business:
1. SOLE PROPRIETORSHIP
A sole proprietorship is where a single individual owns and runs the business. There is no legal distinction between the owner and the business and the owner is personally responsible for all the debits, obligations and liabilities of the business.
Pros:
- Easy and Cheap Setup: Minimal paperwork and low startup costs. It is the simplest and most common form of business structure and there is no distinction between the owners and the business. Typically, you often just need the necessary licenses and permits to operate. But you will need to file for a business certificate (D/B/A) if you want your business to operate under a name different from your legal name.
- Complete Control: Sole proprietors have complete control over all business decisions.
- Tax Benefits: Sole proprietorships are pass-through businesses, which means that business profits and losses are passed through to and reported on the sole proprietor’s personal tax returns. See Sole proprietorships | Internal Revenue Service. The business is not required to file a separate tax return and there is no double taxation on business profits like a C Corporation.
Cons:
- Unlimited Personal Liability: This is the biggest drawback. As a sole proprietorship, you are personally liable for all business debts and liabilities. So, if your business incurs debt or faces a lawsuit, your personal assets like your home, care, etc. are potentially at risk.
- Limited Funding Options: Attracting investors can be challenging for a sole proprietorship as the business is directly tied to you. Usually the only available options are personal finances or third-party loans.
- Business Continuity: The business ceases to exist if you die or become incapacitated.
- Self-Employment Tax: Sole proprietors have to pay self-employment tax (at a current rate of 15.4%) on any net earnings from the business. See Self-employment tax (Social Security and Medicare taxes) | Internal Revenue Service.
Ideal For:
Individual starting a small business in Massachusetts with low risk and minimal funds. Sole proprietorships are also often used by individuals who are testing their business idea to see if it is viable!
2. PARTNERSHIP
A partnership is an association of 2 or more people to carry on as co-owners of a business for profit. See M.G.L. c. 108A. There are three types of partnerships: General Partnership (GP), Limited Partnership (LP) and Limited Liability Partnership (LLP).
Types of Partnerships
- General Partnership (GP): All partners are personally liable for the business’s debts and liabilities and share its profits and losses. Id. In that respect, a general partnership is similar to a sole proprietorship, except that you’re working with at least one other business partner and you could be personally liable for any mistakes or errors made by the other partners.
- Limited Partnership (LP): A partnership with one more general partner who manages the business and has unlimited personal liability, and one or more limited partners who don’t have control or participate in the business and have limited liability. See M.G.L. c. 109. A LP is formed by filing a certificate of limited partnership with the Secretary of the Commonwealth. See M.G.L. c. 109 § 8.
- Limited Liability Partnership (LLP): A GP that has registered and filed as an LLP with the Secretary of the Commonwealth of Massachusetts. See M.G.L. c. 108A §45. In an LLP, each partner can participate in the management of the partnership, but has no personal liability for the debts, obligations or liabilities of the LLP, except to the extent the liabilities arise out of the partner’s own negligence. See M.G.L. c 108A §15(2) -(3). LLP’s are primarily used by professionals like lawyers, doctors, and accountants.
Pros:
- Shared Resources and Expertise: Partners can pool capital, skills, and knowledge.
- Tax Benefits: Like a sole proprietorship, partnership profits and losses are passed through to the partners and reported on each partners’ individual income tax returns. See Partnerships | Internal Revenue Service. There is no double taxation on a partnership like a C Corporation.
Cons:
- Unlimited Personal Liability (for General Partners): General Partners face unlimited personal liability for business debts, obligations and liabilities like a sole proprietorship.
- Potential for Disagreements: Differing opinions and management styles can lead to conflicts. A well-drafted partnership agreement is crucial to mitigate these risks. Consult with an experienced contract attorney for assistance.
- Liability for Other Partners’ Actions: In a General Partnership, each partner can be held liable for the actions of the other partners who are providing services in connection with the partnership. An LLP provides protection against the negligent actions of the other partners.
- Expense: Partnerships can be organized with minimal expense, but having a comprehensive partnership agreement is highly recommended, especially for LP’s and LLP’s. This can get expensive. LP’s and LLP’s also have ongoing annual reporting requirements with the Secretary of the Commonwealth of Massachusetts, like LLC’s and corporations.
- Self-Employment Tax: Partners in a partnership who provide services to the business may be subject to self-employment tax on net earnings like a sole proprietor. See Entities 1 | Internal Revenue Service.
Ideal For:
Businesses with multiple owners who want to share responsibilities and resources and are comfortable with shared liability. An LLP can be a good choice for certain professional practices where the partners wish to be involved in the management of the business while still enjoying limited liability from the debts and obligations of the partnership, including the negligent actions of the other partners.
3. LIMITED LIABILITY COMPANY (LLC)
An LLC is a business structure formed under M.G.L. c. 156C by at least one person by filing a certificate of organization with the Secretary of the Commonwealth. If properly formed and run, LLC’s can protect its owners from personal liability for the debts and obligations of the business, and offer liability protection similar to a corporation. Owners of an LLC are called “members” and they can be individuals, partnerships, corporations, LLC, and others.
Pros:
- Limited Liability: This is the primary advantage. Generally, so long as the LLC is properly formed and maintained, the personal assets of the members can be protected from the business debts, obligations and liabilities. See M.G.L. c. 156C §22.
- Management Flexibility: An LLC may be managed by its members, similar to a partnership, or by one or more “managers” who may or may not be a member of the LLC, which is similar to a corporation or LP. See M.G.L. c. 156C §24. This is very different from a corporation which has a rigid management structure.
- Flexible Taxation: LLC’s have significant flexibility about the way they are taxed, depending on the number of members and any election made with the Internal Revenue Service (“IRS”). See Limited liability company (LLC) | Internal Revenue Service. As a result, LLC’s can be taxed as a sole proprietorship, a partnership, a C-Corporation or a S-Corporation!. This is very different from sole proprietorships, partnerships or corporations who cannot choose how they want to be taxed.
- Less Formality Than Corporations: LLC’s have less compliance requirements to follow than corporations with respect to formation, management, record keeping, and ongoing maintenance. Thus, they can be less expensive to run,
Cons:
- Expense: Setting up and maintaining an LLC can be more expensive than a sole proprietorship due to state fees and additional paperwork. The ongoing annual report for an LLC that needs to be filed with the Secretary of the Commonwealth is also more expensive ($500) than the annual report of the corporation ($125).
- Complexity: Setting up an LLC is more complex than setting up a sole proprietorship or a general partnership. And although less formal than a corporation, the flexible taxation options require careful documentation and record-keeping to comply with applicable IRS regulations.
- Potential for Self-Employment Tax: If taxed as a pass-through entity (like a sole proprietorship or partnership), members will pay self-employment tax on their share of the profits.
Ideal For:
An LLC is ideal for a wide range of small to medium-sized businesses seeking liability protection and flexibility in taxation, management and other areas and don’t want to deal with the strict requirements of a corporation. It’s a very popular business structure for many startups and established businesses in Massachusetts.
4. CORPORATION (C CORPORATION)
A corporation, sometimes called a C Corporation or a C Corp., is a business structure that is entirely separate from its owners, called shareholders. Corporations can make a profit, be taxed, and can be held legally liable under their own name. Most corporations in Massachusetts are formed under M.G.L. c. 156D, although professional corporations (for professionals) and non-profit corporations are organized under different statutes.
Pros:
- More Complex to Set Up and Maintain: Corporations require a lot more record-keeping and ongoing regulatory compliance than LLC’s and partnerships to set up and properly maintain, making them more costly to run. See M.G.L. c. 156D.
- More Rigid Structure than LLC or Partnership. By default, every corporation must have a president, treasurer, secretary, directors and shareholders. See M.G.L. c. 156D. Each position has different roles, duties, and obligations that can only be altered, if at all, with some difficulty and expense. Directors and shareholders must also have annual meetings and minutes must be kept.
- Double Taxation: C Corporations are taxed on their profits and shareholders are taxed on any dividends they receive, which can significantly increase the overall tax burden See Forming a corporation | Internal Revenue Service.
Ideal For:
Businesses with significant growth potential, those seeking substantial outside investment, and those that may eventually go public.
5. S CORPORATION (S CORP.)
An S Corporation (or S Corp.) is a special type of corporation that allows profits and losses to pass through directly to its shareholders or owners, much like a partnership or an LLC. To become an S Corp. a corporation must file Form 2553 (Election by a Small Business Corporation) with the IRS and meet stringent eligibility requirements, such as only having one class of shares, certain types and numbers of shareholders, and others. See S corporations | Internal Revenue Service.
Pros:
- Tax Savings: Avoids double taxation by allowing business profits to pass through to shareholders. Can also save on self-employment tax, as compared to a sole proprietorship or an LLC taxed as a pass-through entity, on some profits by paying any owner who works in the business a reasonable salary. See S Corporation compensation and medical insurance issues | Internal Revenue Service.
- Limited Liability: Same as C Corp. Shareholders are generally shielded and not personally liable for business debts and lawsuits.
- Investment Opportunities:: S Corporations can also raise capital by issuing shares, but, unlike a C Corp., there are strict restrictions on the number of shareholders, the types of shareholders, and the types of shares that can be issued.
- Continuity of Existence:: An S Corp., like a C Corp., continues to exist even if the ownership changes.
Cons:
- Restrictions: An S Corp. has strict eligibility requirements on the number of shareholders, the types of shareholders and the types of shares that can be issued. See S corporations | Internal Revenue Service. Violating these restrictions can result in retroactive termination of S Corporation status, double taxation, and other penalties and interest.
- More Complex to Set Up and Maintain: An S Corp. is still a corporation and has a lot more record-keeping and ongoing regulatory compliance than an LLC or a Partnership to set up and properly maintain, making them more costly to run. See M.G.L. c. 156D.
- More Rigid Structure than LLC or Partnership. S Corporations are still corporations and, by default, must have a president, treasurer, secretary, directors and shareholders. See M.G.L. c. 156D. Each position has different roles, duties, and obligations that can only be altered, if at all, with some difficulty and expense.
Ideal For:
Small businesses that meet the IRS eligibility requirements and want the benefits of pass-through taxation and other tax benefits provided by an S Corporation.
Making the Right Choice: Key Considerations for Choosing A Business Structure in Massachusetts
Choosing a business structure for your Massachusetts business isn’t a one-size-fits-all decision. Carefully consider your specific circumstances, goals, and risk tolerance. Here are some key questions to ask:
- What is the nature of the business and its potential risks? Higher-risk businesses often benefit from the liability protection of an LLC or corporation.
- How many owners will there be? This will influence whether a sole proprietorship, partnership, or multi-member LLC or corporation is appropriate,
- What are your tax planning goals? Do you prefer pass-through taxation or are you open to double taxation as a corporation? Do you plan on paying yourself a regular salary (or wages) when the business is started? The answer to these questions will influence what type of business structure works best. Consult with your accountant to see what works best for your current tax situation.
- How much administrative burden are you willing to take on? Simpler structures like sole proprietorships have less ongoing paperwork. Corporations on the other hand, typically have the most ongoing annual recordkeeping requirements.
- Are you planning on raising capital from outside investors in the future? Corporations are generally the business structure most attractive to investors. An LLC or a partnership can take on outside investors but typically require much more negotiation and substantive revisions to the partnership agreements or LLC operating agreements. Sole proprietorship cannot take on outside investors, except in the form of a loan.
- What are your long-term goals for the business? Consider how your chosen business structure might impact future growth and scalability. A sole proprietorship is generally very difficult to scale, whereas a C corporation is generally the best business structure for growth and scalability.
Don’t Go It Alone: Seek Expert Advice
Navigating the complexities of choosing a business structure for your Massachusetts business can feel overwhelming. That’s where expert guidance comes in. As an experienced small business lawyer in Massachusetts, I strongly recommend consulting with legal and financial professionals before making your final decision.
A qualified business formation attorney can help you understand the legal implications of each structure, ensure you comply with the Massachusetts requirements, and draft essential documents like partnership agreements, bylaws or operating agreements. A knowledgeable accountant can advise you on the tax implications and help you choose the business structure that fits your current situation and long-term financial goals.
Ready to Build a Solid Foundation for Your Massachusetts Business?
Choosing a business structure is a critical first step towards building a successful and sustainable Massachusetts business. By understanding the different options and carefully considering your unique needs, you can lay the groundwork for long-term growth and peace of mind.
Don’t leave this crucial decision to chance. Let’s discuss your specific business goals and determine the best structure to protect your assets and set you up for success. Contact Bross Law LLC today for a free initial consultation!
