Choosing among the possible legal structures for your start up business is one of the most important decisions you will have to make. This article will help you decide.
Choosing among the possible legal structures is one of the most important decisions you will have to make when starting a business. Why is this decision so critical? The one that you choose will affect how much you pay in taxes, the amount of paperwork your business is required to file, the personal liability you could face and your company’s ability to get funding.
To help you make the right choice, we’ve put together a primer on the available options. Here are the types of Business Structures:
Sole proprietorship: This is the most popular form of business organization and as the name suggests, it is a one-person ownership. It is only natural that of all the types, this is the simplest to set up and maintain. However, you will still have to comply with local registration rules, apply for a business license or permit, and follow certain laws to make your business legitimate. In this type of structure, you are personally responsible for paying income taxes and you are also liable for all business debts.
Partnership: This is a business entity involving two or more people, called partners, who agree to share the responsibilities of running the business. Partners not only share profits but also any liabilities that are accumulated, regardless of who was originally responsible for generating the debt.
Corporation: This business structure is recognized as a separate legal entity. A corporation has its own rights, privileges and liabilities separate from those of the individuals who own or manage it. The key benefit of corporate status is that promoters are not faced with personal liability. The corporation itself is responsible for paying its taxes and can be held legally liable for its actions. The main disadvantage is that it costs quite a lot to form a corporation, and entails extensive record-keeping and double taxation. Within the corporation structure, there are two options – the traditional C corporation and the S corporation. The former is subject to double taxation but has greater tax planning flexibility and can shield stockholders from direct tax liability. The S corporation has only one level of taxation but is subject to certain limitations, such as the number and type of stockholders it can have.
Limited Liability Company (LLC): This is a type of business ownership that combines several features of corporation and partnership structures. The advantages of this business format are that profits and losses can be passed through to owners without taxation of the business itself and owners are also shielded from personal liability.
Choosing legal structures can seem very complicated but is not so in reality. You just need to understand all the implications before making your choice. Also remember that your business does not have to stay with a particular structure forever – you can always change it as the company evolves.