When you start a business, one of the most important decisions is what legal structure to choose for the company. The route you take will have an impact on the following:
- How much tax you pay
- The amount of paperwork the business needs to do
- Your personal liability
- Your ability to raise funds
Here’s an overview of the most common types of business entities and how they differ from one another.
Sole Proprietorship
This is the most common business category. Formation is a simple matter of being in business, although you may need to complete a “doing business as” form, also. After paying a small fee you receive a certificate with your business name.
Sole proprietors are not required to file annual reports or certain legal documents that other business structures are obligated to provide. They also do not have to file separate tax returns for the business, as all income is counted as personal income and taxes are paid according to the owner’s individual tax rate.
The business owner is, however, personally responsible for all financial obligations of the business. Raising capital can also be difficult, as stock cannot be issued. The sole proprietor’s investment must finance the company’s activities.
Partnership
A partnership consists of two or more people who commit to sharing in the profits and losses of a business entity. The main advantages of this arrangement are that it’s easy to form and income is passed directly to the partners without the business being taxed, a benefit that corporations don’t automatically enjoy.
One of the disadvantages of a partnership is the personal liability issue, because the partners can be personally responsible for all business debt as well as the acts of the other partners. Obtaining long-term financing is easier for partnerships than sole proprietorships, but approvals are still dependent on the individual partners’ assets.
Corporation
A corporation is a legal entity that is specifically created to carry on business. It is separate from its founder, and can be both taxed and held legally accountable for its actions. Corporations can have easier access to capital, and they protect the assets of the owners should a legal dispute arise.
The principal disadvantage of incorporation is the high formation costs and the amount of record keeping that’s required. Double taxation is also an issue, but the Subchapter (S) corporation avoids this problem for smaller businesses by allowing profits or losses to be passed through on individual tax returns, as in a partnership arrangement.
LLC
The limited liability company (LLC) is a hybrid type of partnership that is growing in popularity because owners are allowed to enjoy the benefits of both partnerships and corporations. Owners are protected from personal liability while income and losses can be passed on to the company owners without the business itself being taxed.
Questions about entity formation? Want to talk about which legal structure is best for your business? Give me a call today at (925) 399-1529 and let’s talk!
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