Small Business Deep-Dive #5: Business Structures 101
There are a lot of “make or breaks” when it comes to starting a new business. It’s hard work getting your dream off the ground! If the conditions aren’t just right, it all falls apart, like a poorly-constructed Lego structure.
Speaking of structures…choosing a business structure is one of the most crucial decisions you’ll make when starting your new business. Why? The structure you choose not only affects your tax bill, paperwork, and fundraising, but it has a huge influence on your personal liability. How vulnerable, exactly, do you want your private assets to be if your business goes under?
The answer is probably “zero.” But how can you guarantee that? By carefully researching business structures and selecting the best one for you!
This week’s deep dive is all about business structures. Keep reading to learn about the four most common structures so you can choose the perfect fit for your business.
What are informal business structures?
Looking to get your entrepreneurial feet wet? Informal business structures offer the simplest options to test the waters. They’re great for businesses with a small client base and low risk.
Keep in mind, these structures don’t offer liability protection. In addition, you’ll still be paying self-employment tax to the tune of 15.3%.
What is the best solo structure?
Have you ever thought “this can be more than a hobby?” Then a sole proprietorship may be for you. This lean, mean structure is no assembly required.
No need to file with the government. You don’t even need an EIN! That SSN will do just fine. Simply performing business activities makes you a sole proprietor.
This no-fuss structure features pass-through taxes. That’s right. All the profits of a sole proprietorship pass through to the owner and are taxed as personal income.
However, that pass-through feature includes liability. Turns out that pesky paperwork is good for one thing: protection. Not in this case. If your business gets in hot water, your personal assets become vulnerable. Car, house, bank account—and that could spell some serious trouble.
While simple to use, this structure is not very attractive to banks or investors. Not to worry! If all goes well, you’ll be upgrading in no time.
Is there safety in numbers?
Going into business with a friend? Are you sure about that? (Just kidding!)
If the sole proprietorship piqued your interest but you’re driving in the carpool lane, consider a partnership.
A general partnership offers the low maintenance of a sole proprietorship but for more people! And not just people. Governments, non-profits, and businesses can all join a partnership.
Partnerships offer no asset protection, use pass-through taxation, and require no formal filing. You can get going with just a handshake! Watch that grip there, champ. You’ll be sharing profits and liability, so make sure you know exactly who you’re working with.
For the discerning band of entrepreneurs, there are partnerships that offer more protection. However, states are picky about who can utilize them.
A limited partnership puts the liability on one partner while shielding the rest. The partner who takes on the risk is usually the one calling the shots. This structure is good for attracting investors who only want to be financially involved.
A limited liability partnership offers asset protection to all of its members. However, only certain professions may use it.
What are formal business structures?
For the entrepreneur with riskier ventures, a formal business structure is just the ticket.
These beauties offer limited liability and unique tax options. Price is steeper though. It’ll cost you government filings, maintenance, board meetings, and sometimes double taxation. Hopefully you’ll be turning such a high profit, you won’t even notice!
Should you choose an LLC?
Ready to test your mettle? A limited liability company offers protection and flexibility.
This sporty structure features the limited liability of a corporation and the pass-through taxation of a sole proprietorship. No personal risk or double taxation here!
LLCs can have multiple members of all shapes and sizes—as long as they aren’t in the shape and size of a bank or insurance company.
LLCs aren’t for novice users. You will need to file articles of organization with your state. If a member should join or leave, you might need to dissolve your LLC. Avoid this by putting provisions in the LLC agreement to account for ownership transfer.
When should you incorporate?
You’re probably wondering about the pros and cons of the most architecturally sturdy of all business structures: the corporation.
These heavy hitters provide the highest level of protection and come with double taxation plus a lot of regulations. Corporations must file articles of incorporation and elect a board of directors.
Corporations, or C corps, can be taxed, held liable, and turn a profit on their own because they are separate entities. This means shareholders can come and go while the corporation could, in theory, exist forever. They have the same rights as a “legal person.” Uncanny.
The greatest strength of a C corp is limited liability. Shareholders can enjoy the benefits of stocks and dividends without the mess of financial loss beyond their own investment.
C corps are taxed both at the corporate and individual levels. Luckily loopholes and a wide array of deductions mean the corporate effective tax rate can be quite low.
Corporations are most attractive to investors due to their ability to sell stock.
What about S Corps?
Not quite sold on incorporating? Consider the S Subchapter or S corp tax designation.
This small business favorite allows income as well as some losses and deductions to be passed through to shareholders while offering corporate protection. An LLC or sole proprietor can choose this election to bypass double taxation. Just make sure you meet IRS guidelines.
Having trouble deciding?
Choosing a business structure is no small task. Even for a savvy business person. Taxes and liability play a huge role in your bottom line. Make sure you choose the protection you need with the best tax strategy.
Look out for next week’s deep-dive: Naming Your Business.
S corps, LLCs, partnerships, combinations? It’s enough to make your head spin. Make sure you’re thinking straight. Reach out to KYN Accounting today for some even-keeled advice, and start your business with a rock-solid foundation.
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