Are you an entrepreneur, online business owner, or small business owner?
Are you confused about how to start your business?
Do you want to know the difference between a Sole Proprietorship, Limited Liability Company (LLC), or Corporation?
The most important step in getting your small business off the ground is choosing the right ownership structure for your needs.
Whether you’re deciding between a Sole Proprietorship, Partnership, Limited Liability Company (LLC), or Corporation, this comprehensive course will clearly explain the advantages and disadvantages of each one, what the incorporation process entails, and your post-incorporation requirements — such as filing annual statements with your state of incorporation.
Venturing into business takes a lot of consideration, but choosing the best type of business structure that is ideal for you is another thing.
You may have heard of different business structure terms like corporation, partnership, sole proprietorship and LLC, but that is not enough.
If you are an aspiring business owner, it is time for you to know the important details of each structure concerning tax, legal liability, future needs, and other aspects that affect a business.
Read further as this article will guide exactly to what you need to know before opening a business...
What is a Sole Proprietorship?
Sole proprietorship is the structure commonly used by small businesses, as the owner does not need to burden himself of paperwork.
It is viewed that the owner and the manager is one and the same, meaning you have all the administrative control over the business.
Sole Proprietorship Advantages
The fact that the owner is also the operator of the business makes it easy to setup. Forget about arguments on decision-making as you have the sole power on what you want to do with your business. In addition to that, only few fees are involved in this type of structure.
Sole Proprietorship Disadvantages
Being the owner and manager at the same time means, you are also the sole liable for all the financial obligations that are related to your business.
The liability protection is very low and you are exposing your personal assets at risk in the event of business debt or legal complaints.
Moreover, funding may also be a problem because the financial institutions are hesitant to grant loans to sole proprietors.
Most of the time, you need to rely on your savings, personal loans and other financing sources that you have.
Sole Proprietorship Responsibilities
Knowing the highlights and drawbacks of this business structure is not enough as there are obligations that come with it that you need to know. You need to be aware of the tax aspects of the business if you do not want the feds to come after you.
Filing for your business’ income and expenses is not that hard because it is included in the Form 1040, which is the form used for your personal income tax return.
The profits and losses incurred by your business on the other hand will be recorded in the Schedule C, another tax form, that is submitted together with the Form 1040.
Besides that, you also need to calculate your self-employment tax. The Schedule SE is used in calculating for these. Unlike the other structures, sole proprietorship is taxed only once.
Being the sole owner and manager is a two-bladed situation. While it may put your own assets at risk, it also has its appeal with regards to tax because your personal income tax return includes the income and expenses you have because of your business.
Your personal tax return will be determined once the final total amount in your Schedule C is transferred to it. This is quite appealing to many because you can offset with the income you got from other sources any business losses that you experienced.
If you are the kind of person who finds himself more effective when working alone, this business structure is definitely for you. The paperwork that you need to deal is easy compared to others, but you must be ready to put your personal assets at risk.
What is a Partnership?
A partnership at a glance is more or less like the sole proprietorship with the difference on the number of its owners. To call it a partnership, two or more people involved are the owners of a business.
Their relationship is covered by a partnership agreement that might cover but not limited to each other’s type of investment; duties and responsibilities of each partner; what actions to take in the event that a partner wants to withdraw from the business; what will happen to the share in case when one partner meets an ill-fate like an accident or death; anything that the partners deem important business-related aspect to include in their agreement.
A partnership has two varieties. First is the General Partnership, which is the association of two or more people where all has the full liability in all the obligations and debts of the business. It means that all of those who are considered as owners are putting their personal assets for their business.
Second is the Limited Partnership where there are general partners and limited partners. The general partners are those who own and run the business and the latter pertains to those who have investment in it. The limited partners’ assets that are at risk are only those that they invested in the business.
Owners of a business under partnership enjoy tax treatment. Their partnership does not bear the burden of paying the taxes. Instead, profits and losses that they experienced will be passed to the individual owners. This is like the sole proprietorship except that there are more of you who are responsible for the business’ losses.
It may be similar to sole proprietorship, but this is more expensive because of the extensive accounting services and legal works that need to be considered. Drawing the partnership may not be that simple especially if the partners cannot come into an agreement regarding something.
A well-thought partnership agreement is important if you do not want to involve a litigation lawyer later in your business affairs. It is applicable to all partnership deals despite the relationship you have with other partners. Doing so will help you avoid having conflicts later.
All partners are responsible for filing their taxes which involves the Schedule K-1 form that indicates how much of deductions, income and tax credits constitute his share. Reporting of profits that you made is required by filing the Form 1065 even if the partners do not have to pay an income tax for the partnership.
Are you having some trouble raising the needed capital for your business? A partnership could be of help. However, be mindful that limited partnership is only suitable for passive investors and this seldom happens. Opt for general partnerships if your business associates are more likely to be actively involved in the business.
What is a Limited Liability Company (LLC)?
The LLC is the popular choice for small business owners because they can take advantage of the protection offers and lower legal liabilities for the parties involved. Owners of a business under this type can enjoy a hybrid of partnership features and that of a corporation.
Under LCC, owners are immune to personal liability but the owners may enjoy the profits and losses without the taxation. Besides taxation, LLC is also known for the flexibility it offers in its organizational structure where no formal restrictions are imposed.
Listed below are advantages of a Limited Liability Company (LLC):
Like a corporation, a business under LLC is considered as another entity hence, your personal and your partner’s assets are protected. As a result, the debts of an LCC will be the debts of that entity and not of its individual owners.
There are no restrictions on the ownership so individuals, foreign entities, and even some LCCs themselves could pass one of the owners. Most of all, having co-owner/s is not a requisite because a sole owner is also possible.
You can apply a flexible structure where all the members have a part in the decision-making like in partnership or run it with a board of directors like that of a corporation.
Besides the structure, profit distribution is also flexible as LLC can afford to make a decision on how to distribution without being tied to the stake of the members in the business.
With LLC, enjoying exemption in the personal liability also means no wages on the other hand. Unlike the corporation where you could use the profit as a wage, the owners of LCC cannot afford to do that.
Whatever income you accumulate will be part of business’ profit. Taxation is also an issue for investors because of the tax forms that are specialized and the tax-exempt status of some probable investors.
Knowing the details of your state’s law is important to determine the extent if your responsibility in this kind of structure. There are states that require a company to exist only for around 30 or 40 years.
The different taxations imposed by different states is also an issue so make sure that you have in your employ an accountant who is well versed with different rules and regulations about LLCs. The assistance of a lawyer to guide you about the legalities of this kind of business in your state is also a good idea.
What is a Corporation?
Unlike other structures, a corporation stands as a taxable legal entity that is formed to conduct a business.
With this, the corporation itself becomes the one responsible for handling the business’ income and profits. The personal assets of the people involved here are safe and not involved at all with the corporation’s dealings.
The liability protection that the owner will get in using the corporation structure is the biggest attraction that it has to offer. The corporation itself is another entity thus, any debt that is incur will be not be transferred to the owner/s.
Moreover, the personal assets of the people owning a corporation are safe from seizure in the event that huge losses happen. Withdrawing of an investor is not a problem because corporations are capable of raising money by selling its stocks.
Enjoying a liability protection means that there is a heavy bargain on the other end. The organizational structure that a corporation needs is much more expensive and complex compared to others.
There are also more tax requirements and regulations that you need to consider. Each state have their own maze of regulations that needs to be followed where an attorney is of great assistance.
While the entity itself is allowed to earn profit, it also comes as a drawback because of the double tax that you have to pay for its earnings. Mind you, besides the corporate tax that you need to think about, it is subject not only to the state level tax but also to that of the federal level tax.
Avoiding double taxation is possible by paying out the money as salaries of the shareholders of the corporation.
How is this so? This is because tax on earnings that are used for paying compensation by corporations is not required, The Internal Revenue Service (IRS) though applies their limits on those compensation.
You could save around $500 to $1,000 when you file for incorporation without the help of a business attorney but the amount you saved may not be worth it for all the disadvantages that you might suffer. Processing could take longer and there is the risk of missing important details in your state’s law about establishing a corporation.
Filing of annual reports, issuance of stocks, yearly meetings and election of directors and officers are part of a corporation. Keeping the minutes of all the meeting is important as track keeping of all the records plays an important role in this business structure.
People who are involved with a corporation must make clear in their every transaction that they are dealing for their corporation and not themselves.
A corporation offers many benefits but it also has its drawbacks. No definite answer could be given on which is heavier as the answer will depend on you. Given the facts about it, you should consider if this is more suitable for you compared to other business structures.
Need to decide on the right business structure for your business?
Contact Sam Mollaei, Esq., business lawyer, at email@example.com or by phone at (818) 925-0002.
Mollaei Law is a law firm specializing in business law serving businesses and entrepreneurs. We provide legal expertise in all stages of business development by drafting and reviewing contracts and agreements, assisting transactions and negotiating, forming LLC's and Corporations, registering trademarks and copyrights, business planning, and answering any legal questions you may have about your business.