Owning a business comes with many risks and responsibilities, and deciding on the structure of your business is one of the most significant decisions you can make from a legal and tax standpoint. Although we advise consulting your power team of attorneys, accountants, and financial planners when choosing a structure, we understand that some startups and seasoned entrepreneurs are diligent about doing their research before speaking with the experts.
Whether you’re just starting a business or you’ve been operating under one type of entity and are considering making the switch, the following overview of business structures will help you learn which one is right for you.
A sole-proprietorship is a business owned and operated by one individual. It’s the most simple business structure as you don’t need to register a name or file any articles of organization for your business. There are some tax advantages to being a sole-proprietor since business losses can offset personal income, thus reducing your tax liability. Like all business structures, sole-proprietors are responsible for making estimated quarterly tax payments.
There are also disadvantages. Since you are your business, and your business isn’t its own separate entity, you are then responsible for the business’s liabilities. That means any personal assets you own could be seized if the business were to be held liable for damages. Finally, receiving funding can also be difficult as a sole-proprietor and may leave you resorting to personal financing sources and savings.
If you go into business with a partner, your default structure may be a general partnership. Note that there are also Limited Partnerships that are necessary if you have partners who solely invest but are not involved in the day-to-day operations or assume any liability for the business.
Like sole-proprietorships, general partnerships also have a favorable tax treatment but are more expensive to set up from a tax and legal standpoint. Just like sole-proprietorships, the partners of the general partnership are personally responsible for the business’s liability which is a major disadvantage for legal protection. This makes choosing the right business partner extremely important as the decisions they make could put the business and your personal assets at risk.
Limited Liability Company
The limited liability company (LLC) is popular among small business owners and solo-entrepreneurs as a way to legally protect their personal assets from their business. To set up an LLC, one must file articles of organization, and in some states an operating agreement if there are multiple owners of the LLC. The cost of filing depends on the state, but in Illinois it is between $500 and $600.
Although an LLC provides the legal protection of a separate entity, it is taxed similarly to a sole-proprietorship or partnership where the earnings and losses pass through to the owner’s personal tax returns unless you elect for the IRS to treat the LLC as an S-Corp for tax purposes.
A corporation provides two main benefits. One is to provide liability protection to the business owners to keep their personal assets secured and not subject to claims against the business. Another benefit is the business’s ability to raise money by issuing stock. Unlike the sole-proprietorship, partnerships or LLC, corporations also have the ability to retain profits and not pass all income and losses onto the owners. This can be a significant tax savings for the owners of the company.
Corporations are more expensive to set up and often come with higher accounting and lawyer fees due to the complexity of filings and number of rules and regulations that must be followed. Another drawback is that owners of corporations are subject to double taxation because of corporate and personal income tax. One way for small business owners to get around that is to establish an S-Corporation. S-Corps pass income and losses through to the business owner for federal tax purposes so they are only taxed once.
There are many details to consider when picking your business structure. This decision could depend on how you plan to grow, raise money, hire employees, and protect your personal interests. Take the time to consult with an attorney and tax expert before confirming your decision and you will have more peace of mind in knowing how you’ll be protected from a tax and liability standpoint going forward.