Which Business Structure Should I Choose?
As a potential business owner, choosing a business structure is one of the first choices you should make. It can be daunting and frustrating to understand which structure is best for you- especially if you have never been in business before. However, this can impact your business in many different ways and it is important that you understand the various options available.
The business structure you pick dictates many of your company’s activities. You should select one that offers you the best mix between benefits and risks. Additionally, taxation is a huge factor to consider when choosing a structure so you can hold on to as much money as possible in your business. Let’s discuss the most common business structures and how they differ.
The sole proprietorship is the most prevalent structure in the business world. The sole proprietor is the only person that owns and runs the business. If you are just starting out, this structure is simple, quick and may be a good option for you.
With a sole proprietorship, you have complete control over the business and can make all of the decisions. Additionally, unlike with several other business structures, the government only taxes your business earnings one time.
It is, however, important to understand that sole proprietorships are not separate entities. This means that your liabilities and assets are not independent. On their tax returns, the government requires sole proprietors to include all personal income and business expenditures. The sole proprietors are responsible for the debts, liabilities, and losses incurred by the business. In other words, your personal finances can be in danger if your company falls into debt.
Do you have someone who you want to create a business with? If so, a partnership may be the best option for you. When it comes to partnerships, the business is managed and run collectively by two or more people. General partnerships and limited partnerships are two different, common forms of this particular business structure.
In general partnerships, two or more owners manage and run the company. These partners are responsible for their liabilities and debts, sharing gains and losses equally. General partnerships are easier to operate and co-owners have a laid-out agreement or plan at the business’s formation. Profits made from general partnerships are taxed at the personal income level because partners assume liability for the business.
A limited partnership can be appropriate if you have at least one partner who makes business decisions and a different partner who has no authority to make those decisions. A limited partner often invests in the business, but does not take on the liability and potential risks that the general partner does.
With any partnership, it is important to remember that just like with sole proprietors, partners are liable for the businesses debts. Personal finances and assets can be at risk with this option.
If protecting your personal finances is a large concern of yours, you may prefer a corporation. Corporations are more complex and more expensive to start than the other options we have discussed. However, they are considered separate legal entities and are therefore distinct from their owners. If a corporation falls into debt, this will not put the owners personal finances at risk. Corporations offer you the best defense from personal liability and are often highly-recommended for larger, more established businesses.
Another benefit of a corporation is the ability to raise funds. Corporations have the option to sell stock to shareholders in order to get more capital. Therefore, if you intend to expand your company and eventually add shareholders, a corporate framework is a good idea.
There are two main types of corporations you may want to consider: C-Corp and S-Corp. The biggest differences between these two corporation types are the federal income tax requirements.
In a C-Corp, the business is considered its own tax-paying entity. This means that the business itself will need to file a separate tax return where it pays a corporate income tax on its profits. Additionally, if that income is distributed to the business owners as dividends, it is considered personal taxable income. This means that those business owners will also need to pay personal income tax on those profits. This is frequently referred to as “double-taxation” and it is often considered to be one of the biggest downsides to starting a C-Corp.
With an S-Corp, the business elects to have a special tax status that comes along with some advantages. They do file a federal return, but no income tax is required to be paid at the corporate level. This is often referred to as a “passed-through” tax entity. That means that any losses or profits that the business has are reported on the business owner’s personal tax returns. Only the owners of the company are taxable and thus, by opting to function as an S Corp, you can escape double taxation.
Besides the tax requirements, there are some other important differences to note between C-Corps and S-Corps. With an S-Corp you can only have up to 100 shareholders and you cannot have different classes of stock. Therefore, it is always best to hire an experienced business attorney like Bellavia Blatt to help you navigate which structure is the best option for your business.
Limited Liability Companies
Another popular business structure you may want to consider is a limited liability company (LLC). This type of business structure is an interesting hybrid mix between a sole proprietorship, a partnership, and a corporation.
LLCs were built to give business owners the advantage of limited liability. Just like in a S-Corp, all personal liabilities are separate from those of the business. All gains and losses “pass-through” to the owners and they are reported on their personal tax returns.
However, an LLC differs from an S-Corp when you consider ownership. Unlike an S-Corp where you are limited to 100 shareholders, there is no limit for members within an LLC. LLC’s can also have members outside of the United States whereas S-Corps can only have U.S citizens/residents as shareholders.
Finally, management of the company often differs between these business structures. S-Corp’s have officers and a board of directors. Whereas LLC’s can choose to have the owners or managers manage the company. This gives the LLC the flexibility to be run like a corporation or run like a partnership or sole proprietorship.
Which Is The Best Business Structure For You?
Ultimately, all of the options mentioned throughout this article are beneficial for different types of businesses. When deciding on what structure is right for your business, you should pay attention to liabilities, costs, and taxes. The best way to ensure you find the best structure for you is to hire a business attorney. A business attorney will help you understand all of the different options and make the best possible choice. Reach out to us by calling (516) 873-3000 for a free consultation today!