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Best Business Structure For My New Business

Best Business Structure For My New Business

Best Business Structure For My New Business

After planning and dreaming, you have decided to start a company. You have selected a name, identified target customers and got a color scheme ready for your website. But before you get too excited, there are many more things to consider. One of the most important things to decide is the company structure for your company.

Why Your Business Structure Matters

According to the small business association (SBA), your business structure has an impact:
  • The payment of taxes (not the responsibility of your employer) 
  • Personal liability (your business may incur debt or be sued)
  • The filing of paperwork requires 
  • Capital Raising

Decide Early

The SBA highlights the importance of selecting a business structure as soon as possible for as many other important parts of your company hinge on it. Without knowing your structure, you can’t:
  • Register your business with your state
  • Apply for a tax ID
  • Open business banking accounts (the tax ID is a requirement for this) 

Although you can change the structure of your business down the line, SBA warns that this may not be a simple process. If you think about this decision at the beginning, considering current and future business needs, you can save yourself a lot of trouble from now on.

Each structure has advantages and disadvantages. The best choice for you is your situation, preferences and business vision.

Your Options

The most common types of business structures according to IRS are:
  • Sole proprietorship
  • Partnership
  • Corporation
  • S Corp
  • Limited liability company (LLC)

Sole Proprietorship
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Description: This is a one-person business, just as the name implies. The owner has full control. Freelancers who did not form an LLC usually fall into this class.

Taxation: Taxation is imposed on the personal tax return of the business owner. 

Liability: The owner assumes all liability for the business.

Paperwork: The need for paperwork to start and maintain this type of business is relatively small. 

Advantages: The owner has complete control. The entity can easily be formed. Taxation is easy and business losses could compensate for revenue from other sources.

Disadvantages: The owner is on the hook for everything happening in the company. It is also more difficult to raise capital for sole proprietorships companies, as banks may be less likely to give out loans.

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Description: A partnership— general or limited— involves two or more persons who have agreed to join business together. Each partner invests in the company for a stake in the business’ future performance.

All partners have chosen to participate in the active management of the business and in the share of profits and losses through a general partnership.

A limited partnership involves two types of partners — general and limited. General partners own, operate, and assume liability for the business; while limited partners are merely investors. Limited partners are not actively involved in operating the business and any liability is limited to the amount of their investment.

Taxation: While a partnership is required to file an information return containing a breakdown of its financial statements, actual taxation is imposed on the personal return of each partner.

Liability: The partners assume all liability for the business.

Paperwork: There is a greater requirement for paperwork than for a sole proprietorship. Initially, a partnership agreement should be drawn up so that everyone knows the responsibility of each partner, the stake in the company and how the partnership will work in certain circumstances.

Advantages: Partners can pool resources and ideas to start and expand the company. Partnerships do not also pay taxes as separate entities (such as corporations).

Disadvantages: Discord within the group can significantly impact partnerships. A good partnership agreement can help clarify misunderstandings, but many partnerships fail due to internal strife or the rogue actions of one or more of the partners. Additionally, the partners are personally liable for what goes on in the business (unless they are limited partners).

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Description: A corporation is formed when shareholders (owners) buy the company's capital stock. It becomes a separate entity from the shareholders.

Taxation: Taxation occurs twice with a corporation. The corporation is taxed on its profits, and the shareholders are taxed on their dividends. In addition, the corporation can not deduct the dividends it pays or deducts the shareholders from the losses of the corporation.

Liability: The corporation assumes all liability for the business, protecting the shareholders/owners personal assets.

Paperwork: The paperwork to form a corporation is extensive and includes articles of incorporation and 
by laws. The corporation also needs to document yearly meetings and file annual reports.

It is also essential to keep careful financial records that show the distinction between corporate and owner finances. Failure to comply with the requirements may lead to the loss of liability protection, which means that owners are personally responsible, as with partnerships and sole proprietorships.

Advantages: The biggest pro is the liability protection.

Disadvantages: The biggest con is the double taxation, with all the paperwork requirements and regulations closely following. Compliant corporations can be expensive and complicated to form and maintain.

S corp
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Description: An S Corp is a corporation that avoids double standard corporation taxation. 

Taxation: The profits and losses of the S Corp are passed on to each shareholder who reports on their tax returns. 

LiabilityShareholders/owners are protected from corporate liabilities, like the standard corporation. 

Paperwork: The S Corp is subject to the same requirements for paperwork as the standard corporation.

Limited liability company (LLC)
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Description: An LLC offers the tax filing benefits of a partnership with a corporation's liability benefits. Initiated at state level, LLC owners are called members. Most states will allow LLCs to form one-member.

Taxation: LLCs may be taxed as a sole proprietorship, partnership or corporation, depending on the number of business owners and the paperwork submitted. If the paperwork is submitted accordingly, members avoid double taxation and the profits and losses flow into their own tax returns.

LLC members must also pay self - Employment taxes (Social Security and Medicare) on all profits. With an S Corp, owners pay this tax only on the profits they earn instead of on the full profit amount.

Liability: Like a corporation, the LLC assumes the liability for the business.  

Paperwork: Some paperwork is involved in the creation of the LLC. Organizational articles must be filed. And an operating agreement may be a requirement depending on the state in which you form it.

Advantages: The LLC is on the hook for business liabilities.

Disadvantages: LLCs can be complicated if the company operates in multiple states. Each state has its own LLC regulations, so remaining compliant will take more time and money. LLCs also cannot issue stock nor can you pass them on to heirs.

Choosing a Business Structure

Choosing a company structure. So how do you decide for yourself which structure is right?

Entrepreneur recommends thinking with the help of a qualified expert:

Risk Tolerance: How much risk are you going to face? Can you manage that level of risk personally? 

Tax Implications: How can your tax liability be improved? 

Administrative Burden: What is the administrative work required for each structure? Is it worth the trouble?

Your Goals:  What structure would help you to achieve these goals? 

Your future needs: What structure could be needed?

If you conclude that your business is low risk and you do not want a corporation or LLC's administrative burden, you can choose to form a sole proprietorship or partnership.

On the other hand, if it is important for you to shield your personal assets or transfer the company toa heir, you can choose to form a corporation.

This decision is a very personal one with many factors. Research and careful consideration are required to ensure that your business begins and operates as efficiently as possible.

Final Note 

The intent of this article is to provide general information about business structures for entrepreneurs. It does not consider every detail, because each type of structure could easily have its own long item.

Choosing a business structure is a nuanced decision and additional guidance may be required. If you still have any questions, talk to a lawyer /CPA /other professionals. They can help you to deepen your financial situation, assess the level of risk you are taking and comply with your business entity.

Tell us: if you own a business, what structure did you choose and why?

Akshita Banerjee

Akshita Banerjee

Content Writer

Having a keen hobby in writing from university days. I have been writing articles, blogs on various elements. Presently working with DK Business Patron Pvt. Ltd. as a content writer. Diving deep into the on-going generation and writing on same is what I do.