Is 2019 the year you will start your own business? If so, one of the first things you need to consider is the type of business structure that best serves your purposes. The legal structure you choose will affect, among other things, your personal liability, your ability to raise money for your business, and the taxes you pay.
There are four main business entities to choose from: sole proprietorship, partnership, corporation/ S-corporation, and limited liability company (LLC). Each entity has its pros and cons, so it is important to select the structure that makes the most sense for you. Below is a basic description of each.
Sole proprietorship: For income tax purposes, sole proprietorship is the default structure because it is what applies when a business owner has not registered with the state as another business entity. This is also the simplest business structure and typically involves just one individual who owns and operates the business on their own.
Business taxes are included on the sole proprietor’s personal income tax return.
Partnership: A partnership may be a desirable business structure if there is more than one owner/operator. With regard to tax treatment, both profits and losses of the company “pass through” to, or are shared by, the individual partners.
Because they require additional legal and accounting services, partnerships are more expensive to establish than sole proprietorships. For example, every partnership should have a written “Partnership Agreement” that establishes the terms and conditions of the partnership.
Corporation: The corporate structure is one of the most expensive entities to create because of the regulations and tax requirements that apply. Perhaps the biggest benefit for small business owners who incorporate is the liability protection that is offered; the individual owners are shielded from personal liability for the debts of the company. A corporation can also raise money by selling stock and continue indefinitely, even after the original owners die.
However, there are downsides to corporations. For example, business earnings are double taxed (once through the business entity and again through the business owner) unless a workaround is used, and there are much higher operating costs and stricter rules and regulations that must be followed.
S-corporation: An S-corporation has many of the same benefits as a corporation but solves the double-taxation issue. Read more about S-corporations in this article from Entrepreneur.com.
Limited liability company (LLC): LLCs have been growing in popularity in recent years because they offer a combination of the best aspects of partnerships and corporations. LLCs offer limited personal liability, avoid double taxation, and are more flexible to manage.
There are a few downsides to LLCs as well, such as inability to offer stock and self-employment taxes must be paid, unlike with an S-corp.
As you can see, there are many factors to consider when deciding which legal entity to use when starting a new business. A business attorney can provide individualized advice to make sure you choose the right entity and start your business off on the right foot.