Choosing how your business will be structured is one of the fundamental decisions you will make. You may wish to consult an attorney, accountant, or business advisor about which business structure is best for you.
The 5 most common ways to structure a business are as a:
· Sole proprietorship
· Partnership
· Limited liability company
· C corporation
· S-Corporation
Sole Proprietorship
In a sole proprietorship, the business is owned and controlled by one individual. The sole proprietorship is the simplest business form under which you can operate a business. The sole proprietorship is not a legal entity. It only refers to a person who owns the business.
A sole proprietorship can operate under the name of its owner or it can do business under a fictitious name. The fictitious name does not create a legal entity separate from the sole proprietor owner.
The sole proprietorship is a popular business form due to its simplicity, ease of setup, and minimal cost.
A distinct disadvantage is the owner of a sole proprietorship remains personally liable for all the business's debts.
Because a sole proprietorship is indistinguishable from its owner, taxation is straight forward. Income and expenses of the business are reported on your individual income tax return, and profits are taxed at your individual tax rate.
Partnership
A partnership lets two or more people or entities share the risks and rewards of a business venture. Partnerships come in two varieties: general partnerships and limited partnerships. In this article, we discuss general partnerships.
The partners manage the company and assume responsibility for the partnership's debts and other obligations.
Each general partner can act on behalf of the partnership and make decisions that will affect and be binding on all the partners.
One of the major advantages of a partnership is the tax treatment it enjoys. A partnership doesn't pay tax on its income but "passes through" any profits or losses to the individual partners.
Personal liability is a major concern. Partners are personally liable for the partnership's obligations and debts.
Partnerships are more expensive to establish than sole proprietorships because they require more legal and accounting services.
If you decide to organize your business as a partnership, be sure you draft a partnership agreement that details the authority and responsibilities of each partner, how decisions are made, how disputes are resolved and how to handle a buyout. You'll be glad you have this agreement.
It's a good idea to consult an attorney experienced with small businesses to help draft the partnership agreement.
Limited Liability Company (LLC)
Forming an LLC is the simplest way of structuring your business to protect personal assets in case your business is sued.
An LLC is a hybrid operation that combines the beneficial components of corporations and sole proprietorships. An LLC is a business structure where members of the company are not held personally liable for company debt.
All members of an LLC may participate in the active management of the business without risking loss of limited personal liability.
Business income and loss are passed through to the member and is included in his/her taxable income and taxed at each member income tax rate.
LLCs are more formal than partnerships because they have or should have an LLC operating agreement. They are easier to set up than corporations and are much more flexible.
It's a good idea to consult an attorney experienced in drafting an LLC operating agreement.
Corporations
A corporation is a distinct legal person. A corporation pays its own taxes. A corporation can be sued in its own name. A corporation makes contracts in its own name. A corporation pays business taxes and shareholders pay a second tax on dividends.
Subchapter S Corporation
An S corporation is often more attractive to small-business owners than a “C” corporation. That's because an S corporation has some appealing tax benefits and still provides business owners with the liability protection of a corporation.
With an S corporation, income and losses are passed through to shareholders and included on their individual tax returns. As a result, there's just one level of federal tax to pay.
An S corporation must have no more than 100 shareholders.
S corporations do come with some downsides. For example, the legal and accounting costs of setting up an S corporation are greater than an LLC or Partnership. An S corporation can only issue common stock, which can hamper capital-raising efforts.
They must file articles of incorporation, hold directors and shareholders meetings, keep corporate minutes, and allow shareholders to vote on major corporate decisions.
Each state has different requirements for an S corporation. Consult an attorney in your state to determine the rules that apply to your business.
Other Considerations
Up to this point we have been primarily concerned with taxes and owner liability. There are however other factors to consider, for example:
· Ease of formation,
· Management
· Number of owners
· Transferability, and
· Ability to raise capital
Because selecting a legal structure can have a lasting impact on your success, you should consult an attorney experienced in setting up legal structures for businesses.