Which legal structure is best for your business?
There are many legal structures that can be used to start your business, and the one you choose will depend on your needs and goals for your business. Generally speaking, there are four main types of business structure; sole proprietorship, partnership, corporation, and limited liability company (LLC). Each type of business comes with its own advantages and disadvantages, so it’s important to choose the one that fits your specific needs the best. This article will help you understand the differences between these business structures in order to help you decide which is right for you. After you decide, check out our article on the steps to starting a business.
If you plan to start a small company with no employees, operating as a sole proprietorship might be right for you. Sole proprietorships are fairly easy to set up and maintain. However, they also come with some disadvantages that many people overlook when making their decision. For example, if your company starts to generate income, you’ll need to file personal income tax returns in addition to any business taxes required by law. And if something happens while running a sole proprietorship—whether it’s a legal issue or a moral dilemma—you’re on your own financially and legally because there’s no separation between you and your business. This can make life complicated in some instances, especially if someone sues you or thinks they have grounds for doing so because of something illegal going on at work.
A general partnership involves two or more individuals who have joined together to conduct a trade or business. Each partner is responsible for his own actions as well as those of every other partner. If one partner acts unlawfully, all partners are legally liable. This type of partnership also has no limit on its potential liability. So, if you are part of a general partnership, you are at risk of losing everything if anything goes wrong with your business dealings. That’s why it’s usually not advised that new businesses start out with general partnerships. Unless you are certain that your business will remain small and local, avoiding legal structures like these should be your goal.
Limited Liability Company ( LLC)
LLCs have many of the same legal and tax characteristics as a corporation, but without being subject to all of its formalities. LLCs are formed by filing a limited liability company certificate with your state’s division of corporations or secretary of state, then designating a registered agent to accept legal service on behalf of the LLC. Operating an LLC requires fewer formalities than a corporation, so it can be easier to set up and manage than a corporate entity, although more complex than a sole proprietorship or partnership. For example, you don’t need to hold annual meetings or elect officers—but you do need to keep track of profit-and-loss statements. As an owner of an LLC, you receive profit through either regular draw payments or distributions at year-end (or some combination thereof).
One type of legal structure that may benefit smaller businesses (specifically, those with less than 100 shareholders) is an S corporation. What separates an S corporation from a C corporation, as previously discussed, is how it pays taxes. In addition to being a pass-through entity that has limited liability, an S corporation generally doesn’t pay federal income tax itself; instead, its shareholders pay taxes on their share of profits on their personal returns. Also, in most cases, owners can write off losses each year against other earnings. These features make an S corporation a viable option for small businesses looking to keep taxes low and reduce their overall expenses. There are some specific requirements you must meet when setting up an S corporation—for example, it must be domestic and not foreign and you can only have one class of stock—but once these are met you could potentially save money on taxes every year by becoming one.
When you form a corporation, you can elect to make it taxed like a traditional C Corporation. This means profits are taxed at both the corporate level (at an average of 15 percent) and also when you distribute dividends to shareholders (which are then subject to personal income tax). The benefit of this legal structure is that it shields shareholders from liability. If there’s ever any kind of dispute with creditors or customers, it’s not you who’s on the hook—it’s just your corporate assets. That said, one big drawback with corporate structures is double taxation—the government taxes profits at both levels. So if you do choose to go with a corporation, save enough money so that Uncle Sam isn’t robbing Peter to pay Paul. Also keep in mind that corporate entities must file formal tax returns and pay estimated quarterly taxes throughout the year, which is something sole proprietorships don’t have to worry about. Just remember: Any time you form a company, you’ll need to hire a lawyer. But once everything’s established, running your business as a corporation will be fairly straightforward (you’ll still need professional help with financial reporting and other crucial tasks). It generally doesn’t cost much more than setting up as a sole proprietorship or partnership. And since corporations have their own separate tax ID number, keeping track of all those forms can be somewhat simpler too.
There are many different legal structures that businesses can adopt. Knowing which one will work best for you and your company’s goals is an important part of determining whether or not to start a business in the first place. Doing some research on which type of legal entity might be right for you and how it may impact your taxes and personal finances will make starting a business less daunting. That being said, we recommend talking to a lawyer and accountant to determine the best legal structure. They are legal professionals and will know the individual nuances you will face. We also recommend checking out the Small Business Administrations‘ information on business structures.