One of the very first administrative decisions you must make after deciding to go into business is what type of entity, or business structure do you want or need? Depending on which structure you choose, there will be legal and tax considerations that go along with the selection.
Available Business Structures:
Sole Proprietorship
Partnership
Corporation
Limited Liability Company (LLC)
While you may be able change the business structure (there are limitations with corporations) at any time but to avoid additional costs you should try and set up your business structure based on your current need only.
A Sole Proprietorship is the most common type entity. It is the easiest to set up and least expensive option. The owner operates the business and is personally liable for all of the business debts and actions of the company. The owner will report all business activity on their personal tax returns. You will need to file a form “Schedule C” along with your federal form 1040. A drawback from operating a business as a sole proprietorship is the fact that the owner is personally liable for the company’s actions.
With Partnerships, you still have the liability issue as you do with a Sole Proprietorship, plus considerable time must be taken to establish the “Partnership Agreement” which must clearly stipulate every aspect of the business. I’m not a huge fan of partnerships, I have seen life long friends and family members go into business together and end up having a battle over a business – their relationships were never the same afterward.
The “Partnership Agreement” will have to be written by an attorney and should describe with no uncertain terms how the partnership will handle profits, liability and the equity of each partner. Great care must be made to also come up with a partner “buy out” arrangement. Not something that folks who are going into business together will automatically think about at first, but certainly should.
Corporations are complex and expensive structures and are simply not appropriate for the bulk of new start up businesses. Depending on some specific needs of the owners a corporation (keep in mind there are several types of corporations as well) is typically not the first option for a business entity. There are several mandates that a corporation must follow and attorneys and CPA’s must be utilized to obtain all of the consideration and tax ramifications of each corporation type. Obviously the “double taxation” theory comes into play where the corporation is taxed on the company profits and the owners are taxed on the income that they receive from the corporation on a personal level.
An LLC is the second most common structure, there is limited personal liability involved yet can operate as a sole proprietorship or partnership. Depending on the type of LLC selected, all business activity can be reported on personal tax returns. In a future blog post I will go into detail regarding the steps needed for you to become an LLC as this is what I believe to be the best option since it provides a “shield” from liability.
LLC Types:
Disregarded Entity (Sole Proprietorship) or Single-Member LLC
Partnership
Corporation
LLC’s are formed under the state and the above classification is required only for federal income tax purposes. You may still have a business “name” with a sole-proprietorship; you don’t have to have an LLC or other type of entity to have an actual business name. (D/B/A). See US Small Business Administration’s website for additional information (www.sba.gov).
Please give me a call to discuss further the advantages and disadvantages to all business structures.
