Starting your own business can be an exciting time, but what type of business entity should you use? There are advantages and disadvantages to every type of structure.
The key is to consider your needs and then simply match them to the business entity that makes the most sense.
Let’s look at the most common structures for the small business owner:
Sole proprietorship. With a sole proprietorship, legally, you have no separation from the business. You would report the business income as personal income. Also, the business debts and liabilities are your debts and liabilities.
Partnership. This is essentially the same as a sole proprietorship, but with more than one business owner. Sole proprietorships and partnerships make the best sense for smaller service businesses (little business debt) and those with limited assets.
If you’re going to be selling products, you’ll have inventory. Inventory typically means debt, since there is usually a period before the bill comes due.
Be careful about using a partnership or sole proprietorship in this situation. If you can’t pay your bills, everything is fair game for the bill collectors, including your house, car, bank accounts, and other assets.
Limited Liability Corporation (LLC). A limited liability corporation separates the owner from debts, liabilities, and legal judgments against the business. In practical terms, in theory, any claims against your business could not result in you losing your personal property or assets.
It’s smart to consult an attorney to set up your LLC in a way that the courts don’t “lift the veil” of separation between your corporation and your personal assets.
For tax purposes, an LLC is handled the same as a sole proprietorship or partnership. Your business income is reported as personal income.
C-Corporation. From a liability standpoint, a c-corporation is similar to a limited liability corporation. Your personal assets are safe from your business-related issues. However, for tax purposes, the business is taxed separately from personal income. The business itself is taxed.
You would be taxed for whatever salary or bonus you receive. This would be considered personal income.
Corporations and limited liability corporations make a lot of sense for owners that have a real risk of being sued or the possibility of creating a lot of business debt. It’s also worth considering for those that have considerable personal assets.
Corporations also allow for the issuing of stock.
Keep in mind that the corporate tax rate in the United States is brutal. That’s why so many corporations have a small office in another country and declare their headquarters. Unless you want to raise money by issuing financial instruments (stocks and bonds), the C-corporate structure is probably not the most beneficial choice.
S-Corporation. The S Corporation has the same legal protection as a C-Corporation and LLC from a liability standpoint. The S-Corporation may offer greater tax incentives as profits are taxed as a pass-through entity avoiding the double taxation of the C-Corporation.
Offering both the benefits of an LLC with one level of taxation and the protection of a C-Corporation it is often a smart choice for many small businesses. However, there are limitations and restrictions regarding the number and types of shareholders. There is only one class of stock for this corporate structure.
In order to best weigh your options, it is advised you speak with an attorney to determine how this classification may impact your business.
Nonprofit. If your business will rely on donations and carry out a purpose that serves the community, you might consider a nonprofit corporation structure. Suitable purposes include educational, scientific, religious, or charitable purposes.
The income received in the form of donations is typically not taxed.
Setting up a business doesn’t have to be difficult. Choose the structure that best suits your needs. Some forms of business are more complicated and expensive to set up and maintain than others. Check out all the details before making your decision and get some expert help. If you need assistance getting started, contact our law firm by clicking below to schedule a free discovery call: