Business Structures: Which One is Best for Your Business
Choosing from all the different business structures -- LLC, partnership, sole proprietorship, or corporation -- for your business can be difficult and will depend on your preferences and the type of your business.
Whenever you start a business, you will have to select one organizational type from out of all the different business structures. This choice 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.
There are some criteria that you can use to find the business structure that works the best for your purpose. These criteria are:
- The different types of liabilities that come with each business structure
- The expenses and procedures associated with establishing and continuing to run the various business structures
- Income tax
- Investment needs
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The general rule for this category 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 have a very hard time placing personal liability on you as the owner. Conversely, if you were to organize your business as a partnership or a sole proprietorship, you could be personally responsible for anything the business did wrong.
Expenses and Procedures
In general, there is no special paperwork that needs to be filed in order to establish either of these business structures. In addition, there are rarely any fees associated with establishing or maintaining either of these business structures.
LLCs and corporations, on the other hand, are almost always more difficult and expensive to establish and maintain. In order to establish a corporation or limited liability company, you must file "Articles of Incorporation" with your secretary of state and pay fees associated with the incorporation. The details of the articles of incorporation and the amount of the fee will vary depending upon the state where you set up your business.
In addition, when deciding to form a corporation or LLC, the owners of the business must decide which officers to elect to run the company. LLCs and corporations must keep specific and detailed records of any important business decisions, and follow many other formalities that are associated with these business structures.
The easiest way to think about the different income tax structures that these business structures will use is to break them into two categories -- one comprised of those business structures where the business owners pay taxes on business profits, and one that includes all business structures where the business owners do not pay taxes on business profits.
The first category includes sole proprietorships, partnerships and LLCs. These business structures 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.
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.
Unlike the pass through tax businesses, the owners of a corporation do not pay taxes on the net business profits of the corporation. Instead, the business owners of a corporation pay taxes only on the profits they actually take from the corporation in the form of salaries, dividends and bonuses.
Because 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 to shareholders.
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 do some individuals.
Structuring a business as a corporation allows a business to sell shares of ownership in the business through stock offerings. This is different than the other three business structures, which do not allow the selling of part of the business through the sale of stocks. Because of this investment scheme, it may allow owners of a corporation to attract investors and retain employees more easily by offering stock.
If you never plan on having your business go on sale to the public, however, and don't need the investment incentives to retain employees, you probably do not need to go through the added procedure and cost of forming a corporation. If you desire the limited personal liability that comes from a corporation, you could instead form your business as a LLC. An LLC provides many of the advantages of a corporation while remaining more flexible.
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Prefer to work with a lawyer? Contact a local business organizations attorney, who can help ensure that your business is structured for success.
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