You’re almost ready for your grand opening! You completed your business plan, found a place to rent, filed your fictitious name, and tied up almost all the loose ends. The big question, which you’ve been putting off, is how do I structure my business? What is my personal liability? What are the tax implications and forms that need to be filed? Am I going to be able to raise money with this structure? Many potential business owners struggle with choosing the correct way to structure their business. This decision does not have to be stressful if you are aware of the different business structures. According to an article posted on Entrepreneur Online, the three most common forms of business structures include: sole proprietorships, partnerships, and corporations.
Forming your business as a sole proprietorship is the most common and simplest way to structure your business. Businesses usually choose to structure this way when there is a single owner and operator and a limited number of employees. Taxes are filed on the Form 1040 and profit or loss is recorded on the Schedule C. The bottom line of your business operations is then transferred to your personal tax return. Schedule SE should always be filed. One drawback to this structure is that you are personally responsible for the company’s assets. Raising money through commercial lending may also be difficult. Savings, family loans, or a home equity line of credit may be the only way to fund the venture.
There are two types of partnerships: general partnerships and limited partnerships. In a general partnership all partners assume liability for debt and obligations. In a limited partnership, there is one general partner and limited partners who act as an investor. A general partnership would usually be your best bet unless you have multiple passive investors. One of the major advantages in forming a partnership is the tax advantages. The business does not pay tax on its income but instead “passes through” to the individual partners. The Form 1065 must be filed by the company and each partner must file a Schedule K-1. On the downside, each general partner is liable for the businesses debt. Also a partnership can be unappealing because one partner can make financial decisions for the whole business and you can become liable for these decisions.
Corporations are more complex and expensive than the majority of other business structures. On a positive side, a corporation structure tends to have less exposure to liability. The business is an independent legal entity, separate from its owner. Therefore, your personal assets are not at risk if the business defaults. Another advantage is the opportunity to raise capital. Common or preferred stock can be sold to generate equity for the business to expand, promote, or whatever it is they may need. A disadvantage is the cost of organization. An attorney and accountant will be needed and the hours it takes to set-up a corporation may be costly. Another drawback is double taxation, which is the corporation being subject to corporate tax (both federal and state tax) and also any dividends paid out are taxed.
Choosing the correct entity for your business does not have to be a huge hassle. Before choosing a structure you should consult with your attorney and accountant, regardless of what structure you are considering. For more information about business structures, check out the article at Entrepreneur Online.
Disclaimer: Note, neither Kutztown University Small Business Development Center nor Jump Start Incubator provide legal or tax advice and any information in this is blog is meant solely for information purposes. Kutztown University Small Business Development Center and Jump Start Incubator highly recommend that you contact a licensed practitioner when considering legal and tax issues.