Do's and Don'ts: Choosing a Business Form

Once you make the decision to start your own new business, there are several steps to take early in the process. These include creating a business plan, figuring out how you will finance the business, and selecting a business name. Another one of the initial steps of starting a business is choosing a business structure.

This choice impacts how you file your income tax and protect your personal assets. It affects how you run your business overall. From a sole proprietorship to a C corporation, each form of business has its own benefits and drawbacks. Understanding the differences between a limited liability company (LLC), a partnership, and a corporation is vital.

There are several different business forms, also called business structures, legal entities, or legal structures, each with its own advantages and disadvantages. This article provides information to help you choose a business form. Let's explore the do's and don'ts of choosing a business structure for your small business to help small business owners like you make informed decisions.

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Legal Structures: Overview

Choosing a business structure is very important because it will determine your personal liability as a business owner and tax obligations. There are several types of business structures, the most common being sole proprietorships, general partnerships, corporations, and limited liability companies (LLCs).

A sole proprietorship is the most simple business form and enjoys pass-through taxation, but doesn't protect the business owner from personal liability. A general partnership is similar to a sole proprietorship, except that there are two or more owners. There are also structures called limited liability partnerships (LLPs).

A corporation, on the other hand, is probably the most complex business form but provides the owners with the most protection from liability. Aside from being complex, a corporation is also subject to double taxation. 

A limited liability company (LLC) is a more recent development and has some of the best aspects of sole proprietorships and corporations; LLCs provide protection from liability and enjoy pass-through taxation. While LLCs do not require as many formalities as corporations, there are still certain requirements for forming and maintaining LLC status.

Each entity comes with unique tax benefits and responsibilities towards the Internal Revenue Service (IRS).

The Do's of Choosing a Business Structure

• Do consider your business needs: Match your choice with your business goals and needs.
• Do understand tax implications: Each structure has different tax rates and benefits. For example, LLCs often have better tax treatment compared to C corporations. Know the tax and personal liability consequences of a business entity before making your choice.
• Do protect your personal assets: Opt for structures that have limited liability protection.
• Do think about growth and plan for the future: If you plan to expand, structures like C corps might be better for you. Think about long-term goals, like bringing in new partners or going public.
• Do check with state laws and requirements: Business laws vary by state. Research the rules in your state. Learn about the different filing requirements, including filing fees or documentation needed. Learn about laws on tax returns and tax deductions for your state.
• Do develop a business plan: Your business plan may dictate the options you have in choosing a business form
• Do ask your attorney if something doesn't make sense: Your attorney works for you and should help you understand every part of the business start-up process, from incorporation to winding up.

The Don'ts of Choosing a Business Structure

• Don't ignore tax consequences: Failing to consider tax implications can lead to higher costs.
• Don't overlook formalities: Certain structures, like C corps, require strict adherence to corporate formalities. For example, you might need to open a separate bank account for your business or only make decisions approved by the board of directors. This depends on the type of entity you choose to go with.
• Don't forget about liability: Personal liability can be a major risk in different types of business entities. For example, sole proprietors face the highest risk of personal liability. They are not considered a separate legal entity from their business.
• Don't neglect future plans: Your current choice might not fit your future expansion needs.
• Don't begin operating your business without choosing its form: Operating as a sole proprietorship with the intention of forming an LLC or a corporation will not shield you from being personally liable for any obligations or debts prior to the formation of an LLC or corporation.
• Don't assume you're authorized to do business in other states: Some business entities might need to be recognized outside of their home state before they can begin doing business. At a minimum, limited partnerships, LLCs, and corporations need to register in the states where they will conduct business. You can usually do this with the secretary of state's office.
• Don't panic: Choosing a business form can be complicated. An attorney can make sure that you choose a business entity that is right for you.

Get Legal Help When Choosing a Business Form

If you would like to learn more about different business structures and would like some guidance on which one would be best for your business, you may want to contact an experienced business organization attorney in your area.