Choosing the right business structure mostly has to do with how you want your profits to be taxed and your tolerance for risking personal assets. Choosing the wrong structure might have implications on your business profits.
Which is the Right Business Structure?
The business structures that you should consider include:
Sole proprietorship – this is an unincorporated business owned by a single person and the business profits are reported on individual tax returns. If you are looking for something that is simple and straightforward, this is the best structure.
Partnership – multiple people or companies own a partnership and the profits are divided amongst owners who then report them on their tax returns. The most common partnerships include LLP, LLLPs and general partnerships.
Limited Liability Company – this hybrid structure limits the owners’ personal liability just like a corporation but it allows profits to be taxed on a corporate or member level.
What to Consider when Choosing a Business Structure
- Your Tolerance for Risking Personal Assets
When running a business, you will be at a greater risk of being sued because your entity interacts with the world more than individuals do. In a sole proprietorship, if a person sues your business and wins the lawsuit, your personal assets will be fair game. If you have a general partnership, the creditor will go after the assets of any partner to recover their debt.
However, if your business structure is an LLC, only the general partners will be liable, but the limited partners will only be liable for up to the amount they invested. Researching the differences between LLC and S-Corp will help you make your decision easier while you place your company on the right track.
- How You want Profits to be Taxed
S Corporations and sole proprietorship’s are usually known as pass-through entities because profits are passed directly to the business owners. When tax time comes around, these profits are reported in the individual returns of the owners. The IRS views LLCs as pass-through entities unless they choose to be categorized as corporations.
C Corporations are separate from their owners; this means that profits are taxed at the corporate level. If a corporation gives out dividends, they will come from the after-tax income and shareholders might pay tax on these proceeds.
- How Formal You Want Your Management Structure to Be
When several owners are involved, structuring your business will not be easy. Agreements govern partnerships by specifying how the business profits will be divided and what happens after a partner dies or becomes disabled. An S or C corporation should have a board of directors to represent the shareholders.
On the other hand, an LLC structure has the choice between being overseen by a management team or managed by members.
- The Administrative Complexity You Can Handle
If your business structure is not a corporation, the initial fees and paperwork are light but simple for you to handle without any special know how. However, it would be a good idea to consult an accountant or lawyer for help if you need it. Ongoing requirements will come on a yearly basis.
If you have an S or C corporation, the administrative complexity will increase until you hire a lawyer or an accountant. In most states, you have to jump through legal and tax hoops if you want your corporation to remain compliant. If you fail to file the proper forms, meet the deadlines, and pay certain fees, it might result in penalties.
- What Your Long Term Goals Are
The right structure should not depend on the state of your business today. But, you need to consider where you will be in three to five years.