When starting a business, there’s an abundance of factors entrepreneurs need to consider. But none can be more crucial to the success or failure of a business than choosing the right legal structure — corporation, LLC, partnership, or sole proprietorship. From privacy issues to personal liability, taxes, costs, state and local laws, and a host of other issues, the legal structure you choose for your business can impact your top and bottom lines as well as how you operate. Here’s what you need to consider when figuring out which structure works best for you and your business.
Privacy: For many small business owners privacy is a major concern. According to Findlaw.com, a corporation
must provide much more information to the state than businesses with other legal setups, and this information becomes public record. Sole proprietorships and partnerships don’t require the owner to give up so much information and offer more privacy.Short term vs. long term: “When you’re starting out, what you want to do is spend as little money as possible while you test your product or service,†says Alice Bredin, small business adviser to American Express Open. Since most companies evolve within the first six months to a year, says Bredin, it’s important to look at what structure will best fit the business during that time period. “As your needs evolve your business structure can change over time.â€
Tax implications: Understanding the tax obligations of the legal structure you choose is important. Sole proprietorships, partnerships, and L.L.C.s are known as “pass-through†entities because all profits and
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losses pass through the business owners, who report their share of the profit on their personal income tax return. Corporation owners pay taxes on profits they receive in the form of salaries, bonuses, and dividends, according to NOLO.com, a website that offers do-it-yourself legal advice. The corporation itself pays taxes–at special corporate tax rates–on any profits that are left in the company from year to year (called “retained earnings”). For more on tax implications, visit IRS.gov.
Ease and cost: Sole
proprietorships and partnerships tend to be easier and less costly to form since you don’t have to file any special forms or pay any fees, according to NOLO.com. Conversely, there is a $40 to $800 fee (depending on the state) to register an L.L.C. or a corporation. Remember, with an L.L.C. or corporation, you must also file paperwork with the state, elect officers to run the company, and maintain thorough records.Ownership and liability: If you create a sole proprietorship, all the assets of the business are owned by the owner, according to the Small Business Administration. In a sole proprietorship, you may hire employees but you also assume legal responsibility for the decisions
your employees make. Because a business and its owner are one and the same with a sole proprietorship, owners assume “unlimited personal responsibility†for the business’ assets, according to the SBA, the business’ creditors can go against both the business’ assets and your personal assets, including your bank account, car, or house. On the other hand, the assets of businesses owners in a corporation or L.L.C. are protected. While a sole proprietorship and partnership are easier to set up, when it comes to ownership and liability, the onus is on you.Check out NOLO.com for more on the advantages and disadvantages of each legal structure. Also visit the SBA.gov: http://business.sba.gov/register/incorporation/ and http://www.sba.gov/smallbusinessplanner/start/chooseastructure/index.html.