With launching a new company comes the need to make many decisions. Among them: choosing a business structure. The type you select for your startup affects far more than whether or not your company’s name includes something like “LLC” or “Inc.” at the end of it. The business structure you choose will have legal and tax implications, too.
That’s why I encourage new business owners to learn about the types of business structures available and seek the guidance of legal and accounting professionals when carefully weighing their options.
The most common business structures include sole proprietorship (or general partnership if more than one owner), Limited Liability Company, S Corporation, and C Corporation.
Which will be the best fit for your business will depend on your needs and aspirations.
As you decide on a legal structure, keep these three important considerations in mind:
1. Complexity Vs. Liability Protection: Finding The Right Mix
Many businesses start as sole proprietorships because that default structure offers convenience and simplicity, due to very few compliance requirements. But on the flip side, being a sole proprietor puts your personal assets at risk because there is no legal separation between what you own personally and your business assets.
If that makes you uneasy, but you don’t want to get bogged down in complicated compliance requirements, forming an LLC (if your state offers this option) may be worth a look. The LLC structure protects your personal assets because, from a legal perspective, you are considered a separate entity from your business. With an LLC, you have relatively little formation paperwork and compliance requirements to deal with.
Or you could consider registering your business as an S Corporation or C Corporation. These structures protect your personal assets (and those of any other shareholders) from debts, losses, and court rulings against your business. With a C Corp, that liability protection usually extends to directors, officers, and employees, as well. Note that S Corps and C Corps require following a number of internal and external corporate formalities to stay in good standing with the state. You will likely need to hold shareholder and director meetings, adopt bylaws, file annual reports, and fulfill other requirements to legally operate your business. If you register as a C Corporation, you will face more government oversight than with other structures because of the complex tax rules and higher degree of liability protection.
2. Tax Treatment That Will Treat You Right
Small businesses often find the LLC’s “flow-through taxation” appealing. As is the case with a sole proprietorship, your business’s profits are taxed at the individual level, on your personal income tax forms.
With a C Corp, your business profits get double-taxed. In other words, they are taxed at the business tax rate when they’re earned and taxed again when distributed as shareholders’ dividends. Also, you and other shareholders can’t deduct your business’s losses on your personal income tax returns because a C Corp’s income and loss gets reported at the corporate entity level.
If you’re looking for more tax flexibility, an S Corp may fulfill your needs. That structure allows you to opt to be taxed like an LLC (with flow through taxation) or as a C Corp.
3. Room For Growth
Neither sole proprietorships nor LLCs allow for the sale of company stock. So with those structures, you can’t generate funds for growing your business through investments from shareholders. With an S Corporation, you may sell shares of stock to help you fund your business initiatives. Some limitations apply, however. S Corps limit the number of shareholders to 100 or less, you may only offer one class of stock, and you can’t have entities (such as partnerships and corporations) as investors. A C Corporation on the other hand offers far more opportunity to grow because it has no cap on how many shareholders you may have.
Getting Your Startup Started: Your Next Step
After you’ve done your research and consulted trustworthy legal and accounting professionals to determine which business structure will suit your business best, you’ll need to complete the legal documents necessary to make it official. An attorney can help you with this, you can try to do it yourself (a risky option unless you really understand what’s required to do so), or you might consider using an online legal document filing service (which can save time and money while ensuring your information is submitted accurately). With your business structure set up, you’ll legally be able to embark on the other must-dos involved in launching your startup—and you’ll be full steam ahead toward making your small business dream a reality.
The above content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
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