How to Choose the Right Business Structure?
When you first start your small business, chances are you’re a lot more concerned with creating a product or service that people are going to want to buy (and then convincing them to buy it). You know that, at some point, you’re going to have to figure out how your taxes work, and that you need to decide whether or not you want to incorporate, but those aren’t day one concerns.
Unfortunately for many small businesses, waiting too long to think about your business structure can cause serious problems down the road.
Types of business structures – There are several basic business structures you can choose from for your business:
1) Sole Proprietorship. This is a business that you – and only you – own. For tax purposes, you are your business. Your business income is your personal income.
2) Partnership. This structure is like a sole proprietorship, but for multiple individuals. Each owns a portion of the business; that proportion of the business income counts as their personal income.
3) LLC. A Limited Liability Corporation is a relatively streamlined way to separate your personal and business income and liabilities.
4) Corporation. Incorporating your business separates your business from you as an individual, and while you may own a corporation you’re separate legal entities.
Which type you choose depends on a number of factors.
Four factor for determining the best business structure
There are four areas you need to look at when it comes to picking the best structure for your business:
1) Liabilities and risks. This has to do with the type of business you have. If your business creates certain risks for you or for your employees (for example, if you have a construction business) you probably want to choose a business structure that protects your personal assets from the business’ claims. If someone sues your business, they can’t come after your personal assets. You’ll want to consider either a corporation or a LLC.
2) Cost. Cost is a factor, at least when you’re first getting started. When you start your business, you don’t have to do much as a sole proprietor. You might need to get a business license, depending on where you live, or you may not even need to do that. Setting up a LLC can cost anywhere from $50 to almost $1,000, depending on where you live. If you have limited funds in the beginning (and most small businesses do) then you’ll want to stick with either a sole proprietorship or a partnership.
3) Tax concerns. The first three business structures – sole proprietorships, partnerships, and LLCs – all handle the business profits in the same manner. All profits and losses pass right through the business directly to the business owners. You report the profits or losses on your personal tax return. These three structures all have a similar amount of complexity and paperwork when it comes to filing taxes. A corporation, however, works differently; the corporation pays taxes on its profits, and then you pay taxes on whatever the business pays to you in the form of salary, bonuses, or dividends. Because corporate tax rates are lower than individual tax rates for the first $75,000 or so you can realize a smaller tax bill in this scenario.
4) Investment options. If you want to be able to get investment capital to take your business to the next level, you’re probably going to want to look at forming a corporation. With a corporation, you can sell shares in your company via stock offerings. You can also use stock options as a way to help get and keep employees. If your business is growing quickly and you want to be able to keep pace with additional capital, a corporation is probably the way to go.
As you can see, each structure offers its own benefits, depending on your situation.
Getting set up with the right structure: So, after you’ve decided which structure is right for your business, what’s next? How do you get everything lined up?
The short answer is that it varies from one state to the next. If you’re forming a sole proprietorship, you probably don’t need to do anything. If you’re forming a partnership, you need to draw up some sort of agreement that describes ownership of the business. LLC formation isn’t terribly complex, and usually requires filling out a single form and making the appropriate payment. Forming a corporation is more involved, and will require a good bit more legwork (and substantially higher fees, as well.)
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