If you’re looking to start or have recently started a business, you’re probably wondering…
~ How do I, if I need to register my business?
~ What are the different business types?
~ Which business structure should I choose?
~ What are the pros and cons of ________?
There are numerous business entity types; sole proprietorship, partnerships, limited liability company, corporations, non-profits, cooperative and more. Choosing correctly matters because the main factors correlate with how you plan to grow and develop your business. Before we get into differentiating there are a few more things to consider…
- Difficult to set up or operate
- The tax advantages and disadvantages
- Potential Legal Liabilities
- Difficult to Liquidation Business
- Raising more money as business
- Regulations to keep business active
- How much bookkeeping is required
- What happens to business upon death of owner
This is simplest type of business, sole pros are operated by one person and they’re so easy to set up! This is for people who don’t see the need to worry about personal liability. But, the downside here is THERE IS NO separation from business and owner. Sole Pros are most chosen!
~ It’s easy because it doesn’t require the filing of any papers
~ You’re only taxed once on the personal tax return
~ Unlimited legal liabilities
~ Harder to establish business credit and capital (lenders)
~ Banks are hesitant, you’d have to use personal funds
This is for businesses that have more than one owner and at most 20 people. Just like sole pros, they’re easy to form. Its always advisable to get partnership agreements in the case one partner dies and for distribution purposes. Partnerships are usually successful when its clear who brings what to the table. There are two different types of partnerships: General & Limited.
~ General: A general partnership is one in which all of the partners have the ability to actively control and manage the business. In this instance, every partner is allowed to make business and legal decisions (if there’s no partnership agreement), THERE’S EQUAL AUTHORITY. There’s no limit on personal responsibility for business debts, similar to a sole pro. For example, a partner could lose more than just their investment.
~ Limited: REQUIRES A PARTNERSHIP AGREEMENT. The business and sometimes info on the partners has to be filed with the secretary of state. The difference between the two partnerships is that limited has both general and limited partners. Limited is the one who does not have total responsibility for the debts of the partnership. The most a limited partner can lose is his investment in the business. Technically, they’re more or less an investor in the business, they don’t make management decisions or have authority to run the business.
In a limited partnership, they also must have at least one general partner. The general partner(s) is responsible for running the business. They are the ones with control over the day-to-day management of the business. They’re the ones that have the authority to make legally binding business decisions. General partners are also subject to unlimited personal liability for the debts of the business, just like sole pros!
LLC (Limited Liability Company)
This business type is the commonly chose when separating business from personal. Unlike Sole Pros, their assets are protected in the instance of legal liability. The owner of the LLC goes to the IRS and chooses how they want to be taxed (sole pro, partnership or corporation).
~ Not required to have annual meetings, board of directors or a limited number of shareholders
~ Some disadvantages: legal and accounting costs are higher than proprietorships. LLCs have to file articles of incorporation with the state
~ In most cases an LLC will no longer exist when the owner dies, unless stated otherwise in the operating agreement
Suppose your business is growing and you need to attract more lender and investors. A corporation is a legal entity that’s completely separate from the shareholders who own stock in the company. It has the authority to enter into contracts and buy and sell property. A corporation can sue other parties but can also be sued.
There are two types of corporations, s-corps and c-corps!
~ C-Corp: Double taxation refers to how income earned by a regular corporation is technically taxed twice: once when the corporation earns income, and again when it distributes dividends to its owners (who then pay taxes on those dividends. Why mention it? Because C-Corps get taxed twice! The flat tax rate is 21% for C-Corps!
Fun Fact: The closest tax rate to 21% for W2 Wage Earners is 22%
Out of the two, C-Corps are the most complex! YOU NEED A LAWYER TO GET ESTABLISHED. Owners don’t have personal liabilities for debts of their corporation. A shareholder only risks the amount of their investment in the company.
~ Has more access to financial resources
~ A corporation can sell stock to raise capital
~ Can obtain bank loans or issue bonds for long-term financing
~ Better able to attract more talented and skilled employees than proprietorships
~S-Corp: S Corporations combine the tax benefits of proprietorships and LLCs with the liability protection of C Corps. They avoid double taxation by passing income through to the owners. The structure of an s-corp protects the personal assets of the shareholders. Lenders are more willing to make loans to S corps.
~ Must file articles of incorporation with the state
~ Can’t have more than 100 shareholders
~ Can only have 1 class of stock
~ Fringe benefits provided by the company to shareholder-employees are taxable as compensation
~ Must pay Income taxes (Self-Employed: 15.3%)
Be sure to look at my business starting checklist!
When it comes to spouses who want to do business together, the IRS is like… do whatever you want to do, call it what you want just make sure if you want to be a partnership, then file a 1065 (which is…), in most cases if they don’t incorporate or form an LLC, then it’s a general partnership, treated like a sole pro. In some cases one person is seen as the sole pro while the other spouse is legally an employee. Another option is the qualified joint venture, basically a sole pro with two owners. Only for sole pros who are married filing jointly!
So, I said all that to say this, choose wisely! But if you don’t you can always change it for the next year, you just can go back to what you originally chose for 5 years. My opinion, if its just you and you’re just seeing how it goes, form a sole pro but if you want to protect yourself cause life is unpredictable, then form an LLC or a corporation.