Choosing which business structure is right for you is a crucial step when starting a business. The entity you select has legal, financial and operational implications. Here are three factors to consider when choosing a business structure.
Business owners must meet all federal, state and local tax obligations to stay in good legal standing. The type of business structure you choose impacts your personal liability and which taxes your business must pay.
For example, choosing a sole proprietorship may be the easiest structure to form for a small business startup, but it comes at a price. A sole proprietorship has less government regulations and tax obligations than all the other business structures. It’s taxed at the personal level because you and your business are considered the same legal entity. This means you are personally responsible for all the business’ losses and liabilities.
With an entity structure such as a limited liability company (LLC), business and personal liabilities are separate, like a corporation. Depending on whether you have a single-member or multi-member LLC, there is a requirement to file different LLC tax forms.
Your business structure will depend on the type of industry you operate in, because of common practices and state requirements. For example, real estate investment companies carry a higher risk. That’s why the limited liability company is widely used due to the owner’s liability protection it provides.
Typically, companies offering professional services form partnerships because they provide flexibility and are easy to form and maintain. The liability may be limited or unlimited, depending on the type of partnership.
In order to choose the right business structure, you must understand what liability protection each entity structure offers. In a corporation, LLC, limited partnership and limited liability partnership there are different levels of personal liability protection.
With a corporation or LLC, only the entity can face a lawsuit — not the owners or officers of the business.
A limited partnership is created by one or more general partners and one or more limited partners. Limited partners have personal liability for the company’s debts, but only up to the amount they have invested in the business.
In a limited partnership, general partners have unlimited personal liability for the company’s debts. This can be limited by having a corporation or LLC as the general partner.
In a limited liability partnership, all the partners are not personal liable for the other partners. But they all have unlimited personal liability for the business’s debt.
Once you choose your business structure, you’ll also need to get a tax identification number and file for the necessary licenses and permits. With an employer identification number, your business will also be in a position to build a business credit identity with the major business credit reporting agencies.
Contact SCORE mentors, Small Business Development Centers, Women’s Business Centers, and Veterans Business Outreach Centers for free business counseling and advice.