Are you preparing to start up that new business you’ve been dreaming about? Starting a new business includes making a mountain of important decisions. Perhaps one of the most important decisions you will face is which business structure to choose for your company. This important decision will not only determine the amount of taxes you must pay, but it will also have a large impact on the amount of paperwork required, raising money, and your personal liability.
What structure is best for your business? This largely depends upon your particular circumstances. No one particular structure is best for all businesses. It cannot simply be assumed that one business structure is better than another. Choosing the correct business structure for your business is not a decision to enter into lightly. The best approach in making this crucial decision is to seek counsel from experienced business experts who can assist you in weighing the pros and cons of the different types of business entities available to you.
Types of Business Structures
What are the various kinds of business entities to choose from anyway? There are essentially four business structures to choose from: sole proprietorship, a partnership, a corporation, and a limited liability company. Which type you select for your business will largely depend upon your particular circumstances regarding taxation, record-keeping, and liability.
This is the most commonly selected form of business structure. A sole proprietorship is the easiest to form and allows the owner to have complete managerial control of the business. However, selecting to set up your business as a sole proprietorship also means that you will be held personally liable for any financial obligations the business may incur.
This business structure is appealing to many new business owners because it allows you to include income from the business on your personal income tax forms. This means any losses your business suffers may help offset any income earned from other sources. For many new business owners, it is a win-win situation.
As a sole proprietor, you will not only be responsible for paying annual self-employment taxes, but you will also need to make quarterly estimated tax payments based upon the income earned from the business. In contrast to other business structures, your earnings from the business are only taxed once.
While the pros of a sole proprietorship may at first make it seem to be the ideal solution, there are a few cons to consider. Choosing this structure for your business means you will personally be liable for any liabilities your company incurs. This means that if a legal claim is filed against your business or your business faces a debt, you’re personal assets are at risk.
Before selecting this structure for your business, you should also keep in mind that raising funds for a sole proprietorship can be difficult. Many financial institutions are hesitant to approve business loans for sole proprietors. Most likely, you will need to depend upon your own financial resources to start up your business.
A partnership is comprised of two or more people who own or operate the company. There are two types of partnerships: general and limited partnerships. In a general partnership, the partners agree to manage the company and assume responsibility for the business’s debts and financial obligations. Limited partners in a business serve only as investors. They have no control over the management of the business and do not face the same liabilities general partners do. Including limited partners in a company requires a large amount of legal paperwork and complexities. Unless you have a large number of passive investors, this structure is often not the best choice for a new business. A general partnership between two or more individuals who desire to be directly involved is much easier to form and is often a better choice for a business just getting off its feet.
The tax treatment of a partnership is one of the advantages of this type of business structure. In a partnership, taxes are not withdrawn from the business’s income but passes to each individual partner. When income tax time rolls around, each partner is required to report their share of income, tax credits, and deductions on a separate form with their personal tax filings. This means instead of the business being taxed, each partner shares a portion of the responsibility come tax time.
If you decide to use a general partnership to structure your business, keep in mind that personal liability can be a major concern. Like a sole proprietorship, each partner is personally liable for any debts or obligations of the business. It is a good idea to draw up a general partnership agreement in the beginning stages of your business to avoid any misunderstandings or arguments down the road. If the agreement allows it, any of the general partners can take out a loan, make a business decision, or act on behalf of the entire company. Any decision made by one partner will be binding on all of the partners.
Another thing to consider before setting up your business as a partnership is the amount of paperwork and expenses involved. Partnerships require extensive accounting and legal services to establish and are more expensive to form than a sole proprietorship.
A corporation is created to serve as a legal business entity separate from those who founded the business. A corporation conducts the business and assumes the responsibilities of the company. A corporation can be held liable for its actions, can make a profit, and can also be taxed.
The primary benefit of incorporating a business is avoiding personal liability. Any debts or liabilities incurred by an incorporated business are not considered the responsibility of the owners. If you choose to structure your business as a corporation, you are not putting any of your own assets at risk. Additionally, a corporation can retain a portion of untaxed profits. Yet another plus of setting up your business as a corporation is your ability to raise funds through the sale of stock.
A corporate business structure also comes with various disadvantages. This business structure is far more complex than others. As a result, it is much more expensive and complicated to set up. Corporations must be formed according to the various laws of each state. If you intend to set up as a corporation, you will need an attorney to walk you through it. Tax preparation, accounting, and bookkeeping services are also much more complex than the other business structures and will require greater financial responsibility. Keep in mind that corporations must pay double tax on its earnings. In addition to being subjected to corporate income tax at the state and federal level, shareholders must pay individual income taxes on any earnings received in the form of dividends.
Limited Liability Company
This business structure is steadily becoming a popular choice for companies. A limited liability company, commonly referred to as an LLC, is a hybrid form of a partnership. It allows business owners to enjoy the benefits of a corporation and a partnership.
The biggest advantage of choosing an LLC business structure is for tax purposes. In this business format, profits and losses of the business can be passed through to the various owners, thus avoiding taxation of the business. At the same time, owners are free from personal liability. No limit of shareholders is placed on an LLC, and each member is allowed full participation in the operation of the business.
Like a corporation, setting up your business as a limited liability company can include a greater amount of expense and paperwork than other business structures. An LLC must be set up according to state regulations. Additionally, taxation varies by state. Establishing your business as a limited liability company will require you to obtain attorney and professional accounting services.
How to Choose
Several criteria should be examined before deciding upon a legal structure for your business. You should examine legal liability, tax implications, expenses, flexibility, and future needs. To what extent do you need to be shielded from legal liability? Are you willing to take the risks associated with potential liability claims? You also need to examine what the best structure is to minimize your taxation. Don’t forget to consider the expenses of setting up your business, the services required, and the costs of ongoing administration. What can you afford? Flexibility of ownership and future needs should also be evaluated before making such an important decision. It can be easy to make a rash decision based on your current situation but take into consideration what the future might look like. What if you decide to sell the business in a few years? What will happen to it after you die? A number of questions need to be addressed before you make this all-important decision. The bottom line is don’t take it lightly, and don’t base your decision on what other people have done. Carefully evaluate the current and future needs of your business and any of its owners.
Even after you have settled upon a business structure, keep in mind that circumstances are always subject to change. State and federal laws regarding the structure you choose may be altered at any time. Reassess your business structure every few years to ensure you are using the one that is most beneficial to you and your business.
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