How to Choose a Business Structure
Choosing from all the different business structures (LLC, Partnership, Sole Proprietorship, or Corporation) can be confusing and your choice will depend on your preferences and the type of your business.
You will have to select one organizational type. This determines how your business will be set up and organized. In most instances, you will probably have to choose between a limited liability company (LLC), a partnership, a corporation or a sole proprietorship.
The right choice depends on the type of business, how you want the business to be run, how many owners the business will have and the financial situation of the business. It may not be possible to find the business structure that will perfectly fit all the needs of your business, but there are some criteria that you can use to find the one that works the best.
These criteria are:
The different types of liabilities associated with each business structure
The expenses and procedures required to establish and run the various business structures
The general rule is that the more dangerous or risky the activity that your business will engage in, the less personal liability you want to have.
Both corporations and LLCs allow business owners a type of “limited liability,” where anyone seeking claims against the business will not be able to place personal liability on you as the owner. Conversely, in partnerships or sole proprietorships, you could be personally responsible for anything the business did wrong.
In a general partnership, every partner can be held personally liable for any claims against the business. For example, if your partnership lost a lawsuit for $1 million, you could be personally responsible for paying out the entire $1 million if your partners and the business were bankrupt or insolvent. The same is true for a sole proprietorship, except that there is no one to spread the liability to because you are the sole owner. As a sole proprietor, you are personally responsible for all liabilities incurred by your business.
Expenses and Procedures
Partnerships and sole proprietorships are the easiest to maintain. There is no special paperwork, and rarely any fees associated with establishing or maintaining either of these business structures.
LLCs and corporations are more difficult and expensive to establish and maintain. To establish a corporation or limited liability company, you must file “Articles of Incorporation” with the secretary of state and pay fees associated with the incorporation. LLCs and corporations must also keep records of any important business decisions, and follow other associated formalities inherent to these structures.
Sole proprietorships, partnerships and LLCs are often referred to as “pass-through” tax entities because the taxes on the business profits and losses pass through to the business owners on their personal income taxes. This means that owners of these three business structures can expect to have complex income tax returns.
Business owners of sole proprietorships, partnerships and LLCs must report and pay taxes on all net profits from their business, even if they take no money out of the business’ account during the tax year.
The owners of a corporation do not pay taxes on the net business profits of the corporation. Instead, they pay taxes only on the profits they actually take from the corporation in the form of salaries, dividends and bonuses.
A corporation is a separate tax entity, it must pay taxes on any profits that remain within the company during a tax year, and also on any profits that it pays out in the form of dividends.
There is a tax benefit to forming your business as a corporation. The owners of a corporation do not pay taxes on any profits that the corporation keeps, and the corporation pays taxes at a lower rate than most individuals. This means that a corporation and its owner may pay less in the form of taxes than if the owner had organized his business as a sole proprietorship.
If you or someone you know is in need of a business attorney, call the Kendrick Law Group at 407-641-5847 to schedule your complimentary consultation.