As an entrepreneur, countless decisions will lay before you, and among these this is one of the most important choices you’ll ever need to make in your business:
Namely, should you incorporate, form a Limited Liability Company (LLC), or remain sole proprietor of your business?
It can certainly be alarming to think that this decision really matters. But truthfully, business advisers agree — it can be one of the most glaring wrong decisions that entrepreneurs make as they’re just starting out.
So why exactly does it matter how you secure your business as a structured entity? Here are the major factors this decision will influence:
• How the government requires you to do your taxes
• Whether your personal and business finances are considered jointly (for reasons of liability)
• How you hire employees
• How your intellectual property is protected
• How you receive investments
• How you manage partners with varying stakes
• How you share profits
Standard Business Entity Options
Sole Proprietor
By default, the IRS will assume that your business is a sole proprietorship unless you claim otherwise. Often, this is what self-employed contractors do, and they never change. If this is your choice, however, remember that your business and personal funds will be considered jointly in a sole proprietorship. This means that if someone sues you, they can go after your personal assets as well as your business assets.
Being sole proprietor also means that all revenues will be subject to taxes. In most states, if a business name is used other than the name of the owner in a sole proprietorship, you’ll need to register that name. For more information on this, look up “Doing Business As” or “DBA” online.
Corporation
You’ll find the most settled laws surrounding corporations. In fact, corporations are the oldest form of business structure in the world. With the corporation, it’s easy to receive investments on return for shares, offer shares, and allocate profits according to shareholding.
There are also clear separations between the business dealings of shareholders and personal assets, and this accordingly limits possible issues with liability. In turn, however, your corporation will be taxed before leftover profits are dispersed as personal income to shareholders.
S Corporation
This is a slightly restricted type of corporation. Investors and individual business owners often choose it. The “S” refers to the fact that revenues are going straight to shareholders and being counted as personal income. Taxing authorities need to see this so that taxation falling on the corporation itself is avoided, and corporations are not “double taxed.”
Limited Liability Corporation
If you are interested in having investors and partners join in on your business, an LLC is a great option. The report filing and paperwork associated with forming an LLC is also less stringent than other entity types.
Generally speaking, you’ll need the main “engine” for this entity, which is the Operating Agreement. This acts as a contract between all members of your LLC and is easily customizable. Many startups decide to go with an LLC because it accommodates both silent investors and working members. It’s also easy to use, and all revenues are distributed easily as personal income (or loss) to members.
Singly-Member LLC
A recent variant of the LLC is the single-member LLC. Each state may treat this differently. Generally speaking, LLCs were founded for partnerships, so for this offshoot, there are specific state legislatures and court clarifications required for tax protections and liability. You’ll want to check in your own state for details.
General Partnership
A general partnership is like a sole proprietorship as there are no protections or tax sheltering. This entity is simply two partners coming together in an agreement to create a common enterprise as equal co-owners.
According to the agreement, the revenues will be disbursed to each partner as personal income. If there is a lawsuit, however, it is important to know that the full debt of the business may lay on the shoulders of each partner, which can get messy.
Business Entity Requirements: Knowing the Law in Your State
All states treat various types of business entities differently, so the requirements necessary for forming your entity will depend on your particular state. As such, the necessary information (including procedures and forms) for the formation of each of these entities can be found on your state’s Secretary of State website. Additionally, you should consider local county and city laws as these may vary too.
Making the Final Decision
It is often said that spending money on advice as it pertains to important decisions like how you should form your business is wise. That’s because it can be a lot cheaper than “winging it” and realizing you’ve made the wrong choice in the end. Still, doing your research on the laws and regulations in your home state, county, and city is smart. And this will give you a better idea of the specific questions you’ll want to ask your accountant or attorney.
What you read here is in no way professional accounting or legal advice. It’s simply a general guide to get you started on making this important choice in the formation and progression of your business. As a rule, handling all of these obligations is fairly straightforward, but filing services such as my own can take the startup and annual filing workload off your shoulders, for affordable fees.
What’s most important is to take your time and be diligent about acknowledging each aspect of your business that will be influenced by your final decision.
