After all the soul-searching, family polls and internet research you’ve finally decided on a business. With this one decision, you have just opened up a whole new world of opportunity, as well as responsibility. From business planning to choosing a domain name, starting your own business is a lot of fun and work! One of the most important decisions that you will make, will be your business structure–how you will legally set up your business.
Before you can choose a business structure there are a few other steps to take. First, you will need a business name. As easy as it sounds, it can be difficult to choose a good solid business name, but that’s another conversation… You will need to make sure that that the name you choose (or a similar name) has not already been claimed in your state.
Once you have a great name that will stand to test of time, you will need to consider what is the best legal structure for your business. How you choose to structure your business should be based upon some pretty important factors such as:
- Liability – Your legal responsibility for your business such as debts owed, lawsuits and other legal issues.
- Taxation – This refers to how your business income is taxed by your state and the IRS. Ultimately, this will also affect your personal incomes taxes.
- Record keeping – Good record keeping is imperative to the survival of any business. Your chosen business structure will determine what records you are required to keep.
- Cost – For many being able to afford the cost of establishing one type of entity versus the other is a huge factor. Though this is a major consideration, would-be business owners should not let cost be their major reason. Cutting corners to save a little now, could cost you a lot more in the long run!
Sole Proprietorship: The sole proprietorship consists of one owner. This structure is usually chosen because it is one of the easiest and least expensive to establish–usually $50 or less. The required record keeping is minimal, though it depends upon your area and industry. Legally, this business structure is viewed as a direct extension of the owner. This means that you are responsible for any and all business liabilities and taxes owed.
Partnership: The partnership is very much like the sole proprietorship, except that it consist of more than one owner. The cost to form is usually the same, though there might be additional fees to certify each owner. Like a sole proprietorship, each of the partners is liable for any debts and taxes due.
Limited Liability Corporation (LLC): For many business owners, the LLC offers a convenient balance between a proprietorship (or partnership) and the corporation. An LLC can consist of one or more members. The LLC is a viable choice for many because it protects the members from being completely, personally liable for business debts. When it comes to taxes, the LLC is considered a pass-through entity, because the company’s profits and losses are passed through to the members. This means that the members are responsible for reporting the company’s income and expenses on their personal tax returns and paying the taxes due–although alternative IRS elections are available. The cost to establish an LLC is usually around $150 to $800–depending upon the state–plus the cost of any annual filing fees. In order to form an LLC, members must submit articles of organization, which lists details such member information, the business address and a contact person. Unlike a corporation, the required record keeping isn’t as detailed. Though all businesses, regardless of entity type should keep detailed records.
Corporation: When it comes to business, most people think of the corporation. This structure provides personal liability protection for the owner-shareholders. When it comes to the taxes, many corporations are known for, and disliked, because of the double taxation. This means that both the company and the shareholders pay income taxes on the same monies. The first “round” of taxing occurs when the company pays income taxes on profits at the end of the year. Then if the company decides to pay shareholders dividends, the money that each shareholder receives is considered a capital gain and is taxable on the shareholders’ individual tax returns. Alternatively, the corporation can request an S corporation status with the IRS. As an S corporation, the company is viewed as a pass-through entity and only the shareholders pay income taxes. To form your business as a corporation the cost is about $150 to $800, along with the costs of any annual filing fees. At the time of filing, an articles of organization must be submitted. Unlike the rest of the entity types, corporations have very strict requirements regarding record keeping. This includes detailed financial records, the minutes of mandatory annual meetings and bank accounts and records, separate from the owner’s accounts.
These are the four common types of business structures. As you consider each type, think about the aforementioned factors and what will work best for you.