When you start a business, there are endless decisions to make. Among the most important is how to structure your business. Why is it so significant? Because the structure you choose will affect how your business is taxed and the degree to which you (and other owners) can be held personally liable. Here’s an overview of the various structures.
There are many ways to structure you business. This is not a choice that should be made lightly, or because you neighbor did it this way. Every entity option has its pros and cons. You should know how your entity should conduct itself before you rush into starting one. If you are starting a new business, invest in professional advise BEFORE you move forward. It is a case of you don’t know what you don’t know and it can really bite you in the arse if you think you can be casual about it.
This is a popular structure for single-owner businesses. No separate business entity is formed, although the business may have a name (often referred to as a DBA, short for “doing business as”). A sole proprietorship does not limit liability, but insurance may be purchased.
You report your business income and expenses on Schedule C, an attachment to your personal income tax return (Form 1040). Net earnings the business generates are subject to both self-employment taxes and income taxes. Sole proprietors may have employees but don’t take paychecks themselves. If you are going to be very successful, Sole Proprietorships might be best due to liability issues with your personal assets and that you may pay more in self-employment taxes than another option.
Limited Liability Company
If you want protection for your personal assets in the event your business is sued, you might prefer a limited liability company (LLC). An LLC is a separate legal entity that can have one or more owners (called “members”). Usually, income is taxed to the owners individually, and earnings are subject to self-employment taxes.
Note: It’s not unusual for lenders to require a small LLC’s owners to personally guarantee any business loans. Again, depending on how much income you may generate, all income passed through from an LLC is taxable for self-employment taxes.
Ease of operating a partnership with an unrelated party is attractive about partnerships and may be a reason why an LLC is better than a corporation for your business.
A corporation is a separate legal entity that can transact business in its own name and files corporate income tax returns. Like an LLC, a corporation can have one or more owners (shareholders). Shareholders generally are protected from personal liability but can be held responsible for repaying any business debts they’ve personally guaranteed.
If you make a “Subchapter S” election, shareholders will be taxed individually on their share of corporate income. This structure generally avoids federal income taxes at the corporate level.
In certain respects, a partnership is similar to an LLC or an S corporation. However, partnerships must have at least one general partner who is personally liable for the partnership’s debts and obligations. Profits and losses are divided among the partners and taxed to them individually.