Opening a new business comes with decisions about aspects of business including funding, finances, marketing, business name and logo. One of the most important decisions is the type of legal structure for your company.  Legal structure impacts the paperwork tracked and filed, taxes, personal financial liability and ability to fund your venture now and in the future.  

 

Each business structure carries its own tax consequences so it’s important to consult a business advisor and tax professional.  Setting up the business correctly at the outset will save headaches with the IRS and state taxing agencies in the future. The following are the most common forms of business. Others include limited liability companies (LLC) and limited liability partnerships (LLP).

1. Sole proprietorship is the simplest structure. Typically there is one individual who owns and operates the business. If you’re planning to work alone, this could be the set up to choose.

The tax reporting aspects of this structure are easy because you put the business income and expenses on your personal income tax return and record your profits and losses on a Schedule C which is then filed with your Form 1040.

You will also need to pay self employment taxes and file a Schedule SE. In addition to paying self employment taxes you will be making estimated tax payments if you think you’ll owe at least $1,000 in federal taxes for the year. You can pay estimated taxes in four equal amounts throughout the year. It is best to consult a tax professional.

As a sole proprietor, business earnings are taxed once – unlike other business structures.

Disadvantages include being personally responsible for the company’s liabilities.  Translation: Your personal assets are at risk. Another disadvantage is the lack of funding sources. As a sole proprietor you may need to utilize personal savings and home equity to get the business started.  

 

1. Partnership structure means the business is owned and operated by several individuals.

Partnerships can be limited or general liability.  In a general partnership the partners manage the company and assume responsibility for the partnerships’ debts and other obligations. Under a limited partnership, both general and limited partners operate the business; general partners own and operate the business’s day to day operations while the limited partners typically serve as investors.

If you have not-so-silent partners then a limited partnership may not be the best option for your business. This is due to the administrative complexities. 

A major advantage to a partnership is the fact that the partnership doesn’t pay tax on its income but “passes through” any profits or losses to individual partners. When tax time rolls around, the partnership files a Form 1065 to report the income and loss to the IRS and the individual partners will report his or her share of income and loss on a Schedule K-1.

As with a sole proprietorship, general partners are personally responsible for the obligations and debts of the partnership.
 

1. Corporation is a more complex structure costing more to set up than the previous structures. The corporation is considered an independent legal entity which means the owner’s personal assets are not attached to the business.  The corporation is separate from its owners and thus requires complex regulations and tax requirements.

Another benefit to incorporating is the ease of funding. A corporation can sell stocks in the company to raise funds for future endeavors.

A major downside to incorporation is the cost.  It costs considerably more to set up than the other types of business structures. Each state has its own laws under to which the corporation must adhere. The assistance of a lawyer is typically needed to help set up the corporate structure and file state-specific documentation

Double taxation is another drawback to the formation of a corporation. The owners pay taxes on the business earnings and earnings doled out to shareholders are taxable on the business owners’ personal income tax returns.

 

Whatever you choose, educate yourself about the options before making the final decision.  It is always advisable to sit down with a trusted business advisor before you open a business as he or she could help you navigate the intricacies of forming a new business.  

 

 

 

Related articles

• Why Is a Sole Proprietorship a Good Business Structure? (thinkup.waldenu.edu)
• Why Is a Sole Proprietorship a Good Business Structure? (thinkup.waldenu.edu)