While in the beginning stages of forming a business, one of the most important decisions you will make is choosing a legal structure. It is important to examine the different business structures available to find one that is best suited for your business’s needs. This decision will impact the amount of record keeping required for your business, how much your business will pay in taxes, ability to raise money, and personal liability.
There are four basic types of business entities: sole-proprietorships, partnerships, corporations, and limited liability companies, each with its own advantages and disadvantages. It is important to go over each option with a business lawyer to ensure you choose right structure for your business and to avoid any problems down the road.
A sole proprietorship is the most common and simplest business structure. No formal action is required to form a sole proprietorship as long as the business is owned and run by one person. You will have complete control over all business decision and will be entitled to all profits. However, you will be held personally liable for the business’s debts and obligations. You will be taxed through your personal income tax filings which are generally the lowest rates as compared to other business structures.
A partnership involves two or more owners of a single business that share the profits and losses. There are three types of partnership arrangements; general partnership, limited partnership, and joint venture. Each arrangement pertains to the amount of profits and liabilities (whether its shared or limited), or a time period for a business with a single project. No formal action is required to form a partnership as long as the business is owned and run by two or more people. Each partner is liable for the profits and losses of the business. Since more than one person is involved in the decision making of the business, it is important to establish a partnership agreement that includes contribution, profits and losses, authority, change of ownership, and termination. If a partnership agreement is not created, state partnership laws will determine the owner’s obligations, which is not always the most favorable. The partnership must file an annual information return to report the business’s income, deductions, etc. However, the business itself does not pay income tax, only the partners pay taxes through their own personal income tax.
A corporation is a separate legal entity from its owners and shareholders. This allows the corporation itself to be liable for the corporation’s incurred actions and losses and avoid personal liability. Compared to other business structures, corporations are larger and more complex with complicated tax and legal requirements. Corporations and its owners each file taxes separately, where the owners pay taxes on their income derived from their salaries from the corporation. Sometimes corporations are “double taxed”, which requires the company to be taxed twice when a profit is made, and then again when the dividends are paid to the shareholders. Corporations have the tendency to be time consuming and expensive compared to other business structures, which can be discouraging for smaller companies. This includes the compliance of the extensive and regulated accounting and record keeping. However, smaller corporations can make a Subchapter S election and thereby be taxed as individuals and thus avoid double taxation. S Corporations also have less complex accounting and reporting requirements.
Limited Liability Company (LLC)
A Limited Liability Company is a combination of a partnership and a corporation, allowing the benefits of both. Specifically, members of the LLC are personally protected from the liabilities of losses and actions like a corporation, and have the tax benefits such as a partnership where the business itself does not get taxed. An LLC is less expensive to start up with less registration and record keeping. Additionally, members have fewer restrictions in the sharing of profits that do not require equal shares. An LLC terminates when a member leaves, requiring the winding up of any remaining obligations.
Seek the Help of a Business Lawyer to Help You Decide the Best Business Structure
Seeking legal guidance through this process can ensure that you make the right decision befitting your specific circumstances. Heckler Law Group is here to assist you in every step of the way.