What is an entity structure? Tips to choose the right one
In 2024, 21 million business owners-to-be filed new business applications. However, the application is just the beginning. There are many options to consider when opening a business, but there is only one right answer for structuring your entity. Each entity structure has different benefits and requirements that can either catalyze your success or complicate your growth.
Entities’ structures imbue your organizations with a distinct character, not to mention determine how much it pays in taxes, who is liable for different legal aspects, how and when you can raise money and even what documents are required to be compliant in running the business. While the business entity structure is not the only determinant in these processes — location, stakeholders and industry all play key roles as well — it is the most important.
This guide is not intended as advice to help you establish your business. Instead, it offers a jumping-off point for the larger conversation you should be having about how to structure your business, including:
- What company structure means
- Why choosing the right entity structure is important
- The four most common types of entity structures
- How to choose an entity structure
What is entity structure?
An entity structure refers to the way an organization or business is organized. The structure an organization chooses at inception dictates its legal obligations, financial operations, tax burdens, operational processes and strategic planning.
All entity structures have distinct features across seven components:
- Legal structure: The law holds different entities to different standards. Choosing a limited liability corporation (LLC), for example, comes with legal and tax responsibilities unique to a sole proprietorship.
- Ownership structure: Entities must also decide how ownership is divided, whether there’s a sole owner, a partner or groups of shareholders or members.
- Governance structure: These structures dictate which mechanisms control the corporation, including the roles and responsibilities of the board of directors (if there is one) and executives.
- Operational structure: As the name implies, this component encompasses how the entity will operate and considers hierarchies, reporting lines and more.
- Financial structure: This involves how the entity arranges its finances, such as capital structure, financial management and budgeting.
- Regulatory and compliance structure: Entities of all types must comply with certain regulations, but the requirements will vary greatly. This refers to the systems and processes the entity will use to manage compliance with relevant laws, regulations and standards.
- Strategic structure: Entity structures should be tailored to the organization’s mission, vision, and goals and the arrangement most likely to achieve them.
The different business entity structures
Entity structure #1: Sole proprietorship
Sole proprietorships are one of the most common entities in the U.S.; individually owned businesses have tripled since the 1980s while the number of traditional corporations has shrunk. This is because, in many ways, a sole proprietorship is the most uncomplicated option for opening a business.
It is best for small businesses with only one interested party running the operation. It is the most common business entity structure and tends to involve the least amount of paperwork. These businesses can be owned jointly by a single individual or a married couple. The main drawback is that there is no separation of the owner from the liability of the business, meaning that the owner is responsible for any legal or financial penalties levied on the business and taxes.
Entity structure #2: Partnership
Partnerships involve two or more individuals who agree to be liable for the losses of or share in the profits of a business venture. Without getting too technical, there are generally four types of partnerships.
- General partnerships are the least formal and consist of any unincorporated businesses. General partners take part in the day-to-day operations.
- Limited partnerships are incorporated businesses with both limited and general partners. Limited partners tend to be more passive in business operations, i.e., they act as investors.
- Limited liability partnerships (LLPs) and limited liability limited partnerships (LLLPs) overlap because they both provide greater liability protection for the partners involved, while LLLPs provide less liability protection for certain partners.
If you expect to have many passive investors, one of the limited partnership options (LP, LLP, LLLP) is the best option here. The main benefit of a partnership is that the taxes on any profits or losses are 'passed through' to the individual owners, and when they file their individual tax returns, they report the income there. This means more profits upfront.
Entity structure #3: Limited liability company
Limited liability companies (LLCs) and professional limited liability companies (PLLCs) are the intermediate steps between a partnership and a corporation. They offer both the 'pass-through' taxation that is so beneficial in partnerships and the greater liability protection that exists in corporations.
There are certain drawbacks to this, as these organizations are, depending on jurisdictional law, mandated to dissolve upon the death of a partner. PLLCs are a special form of LLCs for professionals such as doctors or dentists.
Entity structure #4: Corporation
A corporation is the most complex business entity structure we have discussed so far and, as such, the most expensive to arrange. Legally speaking, corporations are entirely separate from their investors. This engenders an incredible degree of protection in terms of liability for those who create the corporation. Still, it also means more tax and regulatory issues to deal with.
Corporations are responsible for their own debts, and thus, the owners assume no risk to their personal assets. The costs associated with a corporation are mainly due to operations and taxes. Business operations involve a much heavier load of accounting and regulatory/compliance resolution, as they are incorporated within a certain state and must navigate the laws of that state.
The burden of taxation on corporations is much higher because corporations must pay taxes, and the profits paid to shareholders are also taxed on their individual tax returns. Depending on the corporation’s structure, sometimes individual taxation can be avoided by paying profits as salaries, as corporations are not required to pay taxes on profits distributed as reasonable compensation. However, given how the Internal Revenue Service (IRS) defines 'reasonable,' these are muddy waters and should be navigated with the help of a legal expert.
There are two types of corporations:
- S corporations: These are the most popular form of corporation due to their structure. An S corporation protects the corporate veil with tax benefits more akin to a partnership; income and losses pass through to individual shareholders to be reported on their tax returns.
- C corporations: Also called standard corporations, these are the entity structures most people think of when they hear the word “corporation.” They are composed of shareholders, directors and officers. The tax benefits of a C Corporation can be split between the shareholders and the corporation, resulting in a friendlier tax bill overall. C corporations can also deduct certain expenses, such as employee benefits like health insurance plans.
Pros and cons of different entities structures
| Entities structure | Best for | Advantages | Disadvantages |
|---|---|---|---|
| Partnership | Small businesses with two or more owners who want to share profits and responsibilities | Simple to form and operate. Pass-through taxation. Flexibility in operations. | Unlimited personal liability (in general partnerships). Potential for disputes. Harder to raise capital. |
| LLC | Small to mid-sized businesses wanting liability protection and taxation flexibility | Limited liability protection. Flexible tax options; Can elect to be taxed as a sole proprietor, partnership, or S-Corp. Fewer compliance requirements. | Can be more expensive to form than a partnership. Fees and rules vary by state. Investors may prefer corporations. |
| S-Corp | Businesses that qualify and want to pass-through taxation with potential payroll tax savings | Pass-through taxation. Limited liability. Potential savings on self-employment taxes. Can attract some investors. | Strict eligibility requirements. More complex to maintain than LLCs. Limited flexibility in ownership and profit distribution. |
| C-Corp | Business planning to raise capital through investors or go public | Limited liability. Unlimited shareholders. Easier to raise funds through stock. Perpetual existence. | Double taxation at the corporate and shareholder levels. More regulations and formalities. Higher administrative costs. |
Factors to consider when choosing an entity structure
How you structure your business significantly influences various aspects of how the organization operates and its ability to succeed. Choosing a structure that will propel your business forward is essential, and it’s not always easy.
Your goal is to find a “just right” structure that offers you a balance of freedom to grow your business and the structures to remain competitive in your industry landscape. As a result, entity structure is crucial to:
Legal, tax and regulatory requirements
Entity structure determines which laws you must follow and taxes you must pay. Regulatory obligations like the U.S.’s Corporate Transparency Act, including required filings, compliance frameworks and governance structures, all tie back to entities’ structures.
Each entity type is also subject to a different tax treatment, which impacts how you report profits and conduct audits. Choosing the wrong entity could expose you to unnecessary legal liability or tax obligations.
Liability protection
Certain entities hold the business and the individuals behind it as independent entities, giving individuals limited liability protection that shields their personal assets. Liability protection reinforces internal risk management by mitigating board members’ and executives’ exposure.
This makes entity selection fundamental to your risk appetite and willingness to navigate operational complexity. Likewise, commingling personal and business finances for some entity structures leads to “piercing the corporate veil,” leaving individuals personally liable.
Control
How do you want your entity to make decisions? Choosing the right entity is essential to having an appropriate governance framework and supportive structures in place. Governance, risk and compliance (GRC) professionals should consider that while corporate entities have strict governance frameworks, LLCs and partnerships typically offer more flexible, albeit potentially riskier, governance.
Clearly defined control structures also help delineate financial oversight, approval authority, and segregation of duties, all of which are key factors in internal controls and audit readiness.
Efficiency
A well-defined entity clearly defines roles and responsibilities for all stakeholders, reducing miscommunications, duplication of efforts and resource wastage. Define roles and governance protocols to improve accountability and reduce non-compliance incidents. A poorly structured entity increases the chance of overlapping responsibilities and overlooked risks.
Bookkeeping, financial reporting and audit trails can also be simpler for more streamlined entities. This may reduce the risk of material misstatements and ease audit burdens, especially for businesses that don’t yet have a dedicated finance, audit or tax professional.
Funding
Investors may feel more confident investing in some entity types over others. Setting up your entity can help you access a wider pool of funding and investment opportunities. The more transparent governance and legal structures are, the easier it will be to issue equity while complying with securities regulations.
The entity structure also affects capital structure, how returns are structured and how improvements are recorded, all of which have implications for audits and tax filings, especially in due diligence scenarios.
Growth
Some entities scale more easily than others. If growth is part of your vision, choosing the right entity at the start will streamline eventual expansions, mergers, acquisitions and more, as will adopting the right software to manage it all.
Scalable entities like C-Corps allow for easier onboarding of new stakeholders, international expansion and compliance with complex jurisdictions. This makes growth a vital consideration when choosing an entity structure, as some can accommodate evolving risk and compliance requirements better than others.
C-Corps more easily supports audit readiness in complex environments and facilitates clean financials for M&A, IPOs, and multi-state operations. Choosing the wrong structure early can create costly tax restructuring down the line.
How to choose an entity structure
Choosing the right entity structure is critical to your business. The structure becomes foundational to your success and sustainability and has far-reaching implications for your operations, finances and more.
As you seek to start a business, evaluate which entity structure is right for you:
- Understand the types of entity structures: We outline the four most common types of entities above, but those details are just the beginning. Thoroughly research each and the laws governing them in your area to understand their function and whether they suit your goals.
- Assess your business needs and goals: Refer back to the seven components explained above and consider your needs for each. Determine how much liability you need, the tax implications, such as income and self-employment tax, how you want to make decisions, whether you plan to raise capital and the operational flexibility you need.
- Evaluate the pros and cons: There is no wrong entity structure, but each has very real pros and cons. Use the table above to evaluate your needs and understand which entity best meets them without undue risk exposure, compliance obligations or tax burdens.
- Consider your industry and location: Some industries have specific requirements or common practices related to entity structure that you must follow to be competitive. State laws also vary, so the benefits of each structure can depend on where you live.
- Consult a professional: Laws related to entity structure are complicated, and it can be wise to seek expert advice. An attorney, an accountant and a business advisor can each offer counsel about different aspects of your business.
- Define your future vision: How will your entity look in five or ten years? Your long-term goals for growth, potential sale or transfer of ownership can all influence which entity structure is right for you.
- Consider documentation and compliance: Once you choose a structure, you’ll have to file the necessary documents and maintain compliance with regulatory requirements, often using a governance platform. Anticipate these obligations and determine whether you can adhere to them.
AI for entity management
Learn how AI can help you turn entity data into a strategic asset.
Download the guideHow entity structure impacts tax planning and risk management
Choosing an entity starts with paperwork, but it will soon shape everything from how much you pay in taxes to how protected you are in a lawsuit. It’s also a critical piece of your risk management and tax strategy, and increasingly, AI-powered tools are helping founders and finance teams stay ahead by automating risk analysis, documentation and audit readiness.
Here’s how this decision-making process can play out in the real world.
From start-up to C-Corp
Rebecca and her co-founders launched a SaaS platform, starting as an LLC for flexibility and ease. Over time, venture capital interest grew, but most institutional investors were turned off by the LLC’s pass-through taxation and ownership restrictions.
In this scenario, their CPA and GRC advisor might recommend converting to a C-corp, with a structure built for scale and the ability to issue multiple stock classes, attract global investors, and prepare for an eventual IPO. However, their CPA also noted that double taxation would be a downside, one that they could navigate with smart tax planning and deferred compensation.
They then used AI-powered entity tools to simulate scenarios like cap table changes, track compliance documentation and auto-generate audit logs — saving time and preventing costly errors during due diligence.
From LLC to S-Corp
John has operated as a successful, independent management consultant under an LLC. He chose the LLC for its simplicity, but as his income grew, he noticed how much he paid in self-employment taxes.
The next best step would be to meet with a tax strategist, after which John might elect S-Corp status. Doing so would allow John to split his income into salary and dividends, reducing payroll tax liability.
To make a move compliantly, John would need tighter bookkeeping, regular payroll runs and more documentation. AI-driven entity management software makes it more manageable to run audits, flag anomalies and prepare quarterly reports that simplify tax season.
Partnership over LLC
Three attorneys launched a boutique legal practice. An LLC would provide greater liability and financial protection for each. Still, they may choose a general partnership for its flexibility, especially if they don’t anticipate taking on debt or liability-heavy cases.
A general partnership would also include a profit-sharing model not bound by strict distribution rules. This could be an ideal fit if the partners’ risk tolerance were higher, they had the right insurance and operating agreement, and they felt protected.
Using an AI-powered dashboard would help them monitor filing deadlines, alert them to regulatory changes and maintain an audit trail for every client transaction, minimizing operational risk without adding staff.
When and why to rethink your entity structure
You shouldn’t take choosing a business entity lightly. But, as your company evolves, you may find that your entity structure needs to grow with it. That’s where you can consider a restructuring or reclassification.
Restructuring means changing your legal entity type; for example, moving from an LLC to an S-Corp or converting from an S-Corp to a C-Corp. It could also involve reorganizing ownership, dissolving one entity and forming another or changing how the entity is taxed.
Here are common scenarios when it’s time to take a fresh look at your entity structure:
- Growing and scaling: It’s not uncommon to start a venture as a simple, flexible, cost-effective single-member LLC. But if you want to onboard employees, expand into new states or attract investors, a more complex structure like an S-Corp or C-Corp might meet your needs better.
- Bringing on new partners or investors: Partnerships and LLCs offer unmatched ownership flexibility, but new stakeholders bring new governance demands. You may need more formal voting structures, defined roles or the ability to issue multiple classes of stock. Restructuring a corporation can also facilitate a more robust risk management framework and accountability mechanisms among a growing leadership team.
- Tax law changes: State and federal tax policies tend to evolve. For example, the 2017 Tax Cuts and Jobs Act made the flat 21% corporate tax rate more attractive for some businesses previously operating as pass-through entities. If your structure no longer optimizes your tax position, you will leave money on the table or expose yourself to unnecessary audits or penalties. Entity management professionals now use AI platforms that model entity-level impacts of new laws across jurisdictions, flagging when a restructuring might be financially advantageous.
- Mergers and acquisitions: Whether you’re acquiring, being acquired or merging with another business, your entity structure can either streamline or stall the deal. Buyers typically prefer acquiring C-Corps due to simplicity in stock purchases and fewer tax complications. Entities involved in an agreement may need to restructure pre-transaction to enable the cleanest, most tax-efficient path forward.
Risks of staying in the wrong structure for too long
Pinpointing the right time to restructure or reclassify is challenging, but there are some real consequences of not making the move:
- Tax inefficiencies: You could be overpaying or missing deductions if you’re eligible for a new entity structure but haven’t yet made the change.
- Investor aversion: The wrong structure can scare off the capital you need to meet your growth goals.
- Compliance gaps: Misalignment between entity type and operations can trigger legal or regulatory exposure.
- Operational drag: Poorly suited governance frameworks can lead to unclear roles, internal disputes and costly missteps.
How AI-powered tools can help you make the right entities structure at the right time
Modern AI platforms can help founders, CFOs and compliance officers zero in on the optimal time to change their entity by:
- Analyzing historical and projected revenue to recommend optimal tax structures
- Monitoring compliance risk based on entity-specific filing and reporting obligations
- Flagging opportunities for tax savings or red flags in the ownership structure
- Simulating M&A or capital raising scenarios to see how different entities would perform under pressure
Complex entity structures require adaptable entity management systems
The more complex the business entity structure, the more complex the documentation. The needs of a business with many different interests across multiple industries are too much to document in the old-fashioned way, and the responsibility for finding the right solution will often fall on the corporate secretary. There is only one right answer in this predicament: a powerful entity management system that can be customized and optimized to cater to the precise needs of the business in question.
Diligent Entities, part of the Diligent One Platform, alleviates the administrative burdens of entity management. Centralize all your critical business information in a simple, secure platform accessible anywhere and tailored to help entities of all kinds visualize their structure.
Learn more about Diligent Entities and request a demo.
FAQ
What are the four types of business entities?
The four main types of business entities are:
- Sole proprietorship: Owned by one person, with no legal separation between the individual and the business. Easy to set up but offers no liability protection.
- Partnership: A business owned by two or more people. Profits pass through to the owners’ personal tax returns. There are general and limited partnerships.
- Limited Liability Company (LLC): Combines the liability protection of a corporation with the tax flexibility of a partnership or sole proprietorship.
- Corporation (C-Corp or S-Corp): A legally separate entity with strong liability protection. C-Corps are taxed at the corporate level; S-Corps allow pass-through taxation for eligible companies.
What’s the difference between legal and tax structures?
A legal structure defines how the state organizes and recognizes your business, meaning an LLC, a C-Corp or a Partnership. It impacts your liability, governance and compliance obligations.
A tax structure determines how the IRS and state agencies tax your business income. Some legal entities, like an LLC, can elect how they are taxed as a sole proprietorship, a partnership, or an S-Corp.
Can I switch from an LLC to a C-Corp later?
Yes, you can convert from an LLC to a C-Corp. Many startups begin as LLCs for simplicity and flexibility, then convert to a C-Corp to raise venture capital, issue stock options or prepare for an IPO.
How do I protect my personal assets as a business owner?
To protect your personal assets, choose a limited liability entity like an LLC, S-Corp or C-Corp. These structures create a legal separation between you and your business, shielding your personal finances from lawsuits, debts, or business liabilities.
Protection only applies if you maintain proper business practices:
- Keep business and personal finances separate
- Follow legal filing and compliance requirements
- Use clear contracts and insurance when needed
AI compliance tools can help monitor risk and automate documentation, making it easier to stay protected.
What’s the best business structure for international operations?
The best entity structure for international operations depends on your goals, risk exposure and tax strategy. Generally:
- C-Corporations are best for U.S.-based businesses expanding globally, as it supports foreign shareholders, multiple classes of stock, and international tax planning.
- LLC with foreign subsidiaries can offer flexibility, but international tax compliance can be more complex.
- For businesses headquartered outside the U.S., setting up a U.S. C-Corp subsidiary is a common strategy to access American markets and investors.
