Are you ready to start your business but not sure what structure you need? If so, read on…
When it comes to starting a company, one of the most important decisions you’ll make has to do with the legal structure you register your business under. This will affect everything from the amount of paperwork you will have to fill out, the personal liability you may face, your ability to raise money, and impact how much you have to pay in taxes. This may sound daunting but ultimately it’s a decision with very few options.
While there are really four main structures, you still have some options; those include a sole proprietorship, partnership, limited liability company (LLC), corporation (C corp, S corp, B corp, close corporation, and a nonprofit corporation), and cooperative. Each structure comes with different tax consequences, so it is important to register your business with a structure that matches your business’s needs.
Choosing the correct structure for your business, in the beginning, is crucial because it could be challenging to switch to a different business structure later on. There could be tax implications, restrictions within your state, and a host of other consequences.
Common types of business structures/entities
The three factors that will affect the type of business entity you choose to register with are liability, record-keeping, and taxation. While deciding to determine which structure best suits your business, it’s always helpful to consult with attorneys, accountants, and counselors.
Let’s take a look at common business structures and what they mean for your business.
Sole Proprietorship
The most straightforward and widely used structure is the sole proprietorship. Typically this involves one person owning and operating the business. For people that work alone, this is the most common entity to register with. Even without registering, the government automatically considers you to be a sole proprietorship if you’re conducting business activities.
As far as your personal assets and liabilities are concerned, they are not separate from your business assets and liabilities. This can be attractive for tax purposes because income and expenses from your business would be included in your personal income tax form. On the other hand, you could be held liable for any debts or obligations of your business.
While a sole proprietorship is appealing to people who want complete control over their business, it can be difficult to raise money because financing sources are usually reluctant to give out loans to sole proprietorships.
Partnership
You will want to look into registering your business under a partnership if your business is going to be owned and operated by two or more people. Partnerships come in two types: limited partnerships (LP) and limited liability partnerships (LLP).
With a limited partnership, one partner or multiple partners assume liability, while the limited partners do not because they usually serve as investors. The investors are not subject to the same liabilities; therefore they have less control.
Limited liability partnerships give limited liability to each owner of a business. An LLP will protect you against the actions of another partner and the debts against the partnership.
Partnerships benefit from not paying tax on income, but rather pass its profits or losses through to each individual partner. While they do require more legal and accounting services, partnerships can be a wise choice for groups who want to try out their business ideas before registering for a more formal structure.
Limited Liability Company (LLC)
Limited liability companies have been around since 1977, but only recently began gaining popularity. An LLC brings together some of the best benefits of partnerships and corporations. In case of bankruptcy or a lawsuit, an LLC protects your personal assets, but your profits and losses are passed through your personal income.
Since members of an LLC are considered self-employed, they don’t have to pay corporate taxes, but they do have self-employment taxes that include contributions to Social Security and Medicare.
It’s important to be aware that most LLCs have a limited life and that could vary from state to state, with some states stipulating that an LLC must dissolve after 30 years. Ideally, an LLC is good for people who want to protect their personal assets, pay lower taxes, and have a medium to high-risk business.
Corporation
Sometimes called a C corp, corporation structures are more expensive and complex because they are a legal entity that is entirely separate from the owner. Since the corporation is an independent legal entity, you usually have to deal with more regulations and tax requirements, but you get protection from personal liability.
Corporations pay income taxes on their profits, often when the company makes a profit, and again when shareholders get paid. However, a corporation can continuously keep running whether a shareholder buys or sells shares.
The most significant benefit of registering your business as an incorporation structure is the liability one receives and the advantages of raising capital through the sale of stock. However, you will most likely have to hire an attorney and an accountant because of complex regulations and tax preparation.
S Corporation
Also called an S corp, S corporations are more appealing to smaller business owners because they are designed to avoid the double taxation of a C corp. There is just one level of federal tax to pay because income and losses are passed to the shareholders and included on their tax returns.
Unfortunately, you must check with your state because some states tax profits above a specific limit and others simply treat S corps like C corps. Also, to get S corp status, a company has to file with the IRS as opposed to registering a business with the state.
Nonprofit Corporation
Nonprofits have tax-exempt status because they provide charity, education, scientific, literary, or religious work. They must register their business with the IRS to receive tax-exempt status, which means they don’t get taxed on any profits they make.
Nonprofit Corporations must follow strict guidelines and laws since the IRS needs to know exactly what happens to their profits. They aren’t designed to make profits for the owners.
Mix and matching
Depending on the type of business you own and operate, it’s possible to register your business under one structure and your tax status under another. The process is complex and less common, but it’s possible to be registered under an LLC and be taxed as a corporation. These decisions are best left to attorneys and counselors with the expertise to guide you in the right direction.
When it comes to all the choices you have while starting a company, selecting which legal structure to register your business with is the most important. Because each structure impacts everything from taxes to liability, it’s crucial to choose one that fits your business’ needs.
Once you decide on your type of Business Structure, be sure to see if a website is right for your business
Super super helpful!