Many people with good ideas have businesses that fail simply because they choose the wrong legal structure. Choosing a right legal structure is one of the most important decisions you can make in a company. This decision affects how much you pay in taxes, as well as the amount of paperwork your business will need to do. It also affects your ability to raise money and the personal liability you face.
It’s a good idea to seek professional advice from business experts to figure out which business structure is best for your company. Those who skip out on getting the expert advice upfront often regret it later when their business fails due to a poorly thought-out structure. Below are the types of business entities, and a few of the pros and cons to each:
1)Sole Proprietorship
The most common type of business organization, a sole proprietorship, is very easy to form. If you own this type of organization, you will have complete managerial control. But you know what they say: with great power comes great responsibility. As the owner, you will be personally liable for all of the business’s financial obligations.
2) Partnership
In a partnership, two or more people agree to share the profits or losses of a business. One advantage of a partnership is that you will not have the tax burden of profits. You also won’t have the benefit of losses. This is because profits or losses are “passed through” to partners, who then report on their own income tax returns. One main disadvantage of a partnership is that each partner is personally liable for the business’s financial obligations.
3) Corporation
Corporations are legal entities that are created in order to conduct business. A corporation is an entity separate from the people who founded it. The corporation itself handles the responsibilities of the organization. The corporation can be taxed and can be held legally liable or its actions, just as a person can. It can also make a profit. The benefit of being a part of a corporation is the avoidance of personal liability. The main disadvantage is that forming a corporation is expensive and requires a lot of record-keeping. While many people think of double taxation as a drawback to incorporation, the S corporation (or subchapter corporation) works its way around this. The S corporation allows income or losses to be passed through on individual tax returns in a way similar to the way partnerships work.
4) Limited Liability Company (LLC)
The Limited Liability Company is a type of business organization that is gaining popularity. This is because it allows business owners to take advantage of the benefits of the corporation and partnership forms of business. One large advantage of this is that profits and losses can be passed through to owners without the business itself being taxed. Owners are shielded from personal liability while this occurs. One disadvantage to an LLC is that the managing member’s share of the bottom-line profit is subject to self-employment tax because it is considered earned income.
If you’re not sure what structure is right for you, it is a great idea to see a professional expert. This is bound to help you make an important decision that can make or break your company.