Small business owners and entrepreneurs have several options when it comes to how they structure their companies. You can learn how to form an LLC or other business entity fairly easily. Choosing which one to form, however, can be confusing. And if you make the wrong decision, you might face tax ramifications and other restrictions. Here are common business structures for startups and the pros and cons of each.
If you’re the owner and operator of a small business and don’t declare it as any other structure, you’re a sole proprietorship. This type of business is easy to establish and gives you complete control over your company and its profits. Taxation is simple, as well. You just record all your business profits and losses on your personal tax return. You might even be able to deduct financial losses or business expenses from your income.
Because you and your business are one and the same, however, you’re liable for any related debts. Your personal assets could be at stake if you owe money or encounter legal troubles. It can also be difficult to raise funding because banks are less likely to lend money to sole proprietorships.
If you co-own your business with one or more people, it makes sense to form a partnership. This partnership can be general, in which all partners assume full control of and liability for the company; or it can be limited, meaning some partners (typically investors) have little or no control over the company and thus are protected from its debts. These types of distinctions are made in the partnership operating agreement. One of the benefits of forming a partnership is that taxation on business profits and losses “passes through” to each partner’s personal tax returns, avoiding the need to pay corporate taxes.
On the other hand, general partners can be held personally liable for company obligations.
Limited Liability Company (LLC)
If you have assets you’d like to protect and don’t want to be liable for company finances or legal issues, consider forming an LLC. As in a partnership, profits and losses pass through to your personal tax return but without the associated personal liability. The company can also have as many partners as you want. The rules and stipulations for LLCs and their taxes can be confusing, however, so you might need to seek professional help to navigate them.
Corporations offer business owners the most protection from liability but cost more to form. You can structure your company as either a C corp or an S corp. C corps often face double taxation — both the company and its shareholders get taxed on profits. On the plus side, these companies can have stock and can raise money more easily than other structures. S corps advantages avoid this double taxation and get taxed like LLCs and partnerships. While S corps have more limits than C corps, they can be more appealing to small business owners.
Corporations must follow strict rules and tax requirements. A tax attorney can help you determine if this is the right business structure for your startup and how to set it up properly. Choose wisely when structuring your new business to avoid tax and liability issues. Factor in your company’s size, location, risk level, and financial needs.