Things to Ask Yourself Before Selecting a Business Type
Business type costs range from minimal for a sole proprietorship up to expensive for a corporation. Here is a list, in order of cost from lowest to highest:
- Sole Proprietorship
To start a sole proprietorship, all you need is a business license for your city, possibly a “fictitious name” statement, and a business checking account. The sole proprietorship is the default business structure. This means that if you do nothing to register your business as another type, you are automatically a sole proprietorship, particularly for income tax purposes.
To start a partnership, you will need an attorney to help you with the partnership agreement and the state registration. There are various types of partnerships that you may form, depending on your business and the state in which your business is located.
- Limited Liability Company (LLC)
To start a Limited Liability Company, you will need to apply to your state Secretary of State to become an LLC, by filing Articles of Organization. You may be able to do this by filing yourself, or you can get an attorney to help.
To start a corporation, you will need to pay an attorney to help you set up your corporation correctly in the state where you will be operating, including a corporate charter and by-laws. Within the category of corporations, you may elect to be a Subchapter S corporation, which has some tax benefits for smaller corporations.
What Happens to the Business If I Am No Longer There?
If you want the business to continue, form a corporation, or put provisions in your partnership agreement or LLC operating agreement to allow the business to continue without you. If you choose a sole proprietorship, the business ends if you leave, die, or can no longer run the business.
How Much Control Do I Have?
Select a sole proprietorship or single-member LLC if you want complete control. In a partnership or multi-member LLC, you will have to share control with your partners (in a partnership) or the other members (in an LLC). In a corporation, you will have a Board of Directors helping you make decisions, so if total control over the business is important to you, don’t incorporate.
Who Receives the Profits and the Losses?
If you want all the profits, you must assume all the losses. Set up as a sole proprietorship or an LLC to keep all the profits (after taxes, of course!). If you set up as a corporation, you will have to give some money to the other shareholders in the form of dividends. If you set up as a partnership, you must share the profits with other partners, in a percentage depending on the terms of your partnership agreement.
Who Pays the Taxes?
How each business type pays taxes (specifically, federal income taxes) is different. Sole proprietorships, LLCs, and partnerships pay their business taxes as owners through their personal tax forms. Because the taxes pass through to the owner personally, they pay taxes on the profit of the business as pass-through entities.
Corporate owners are shareholders who pay taxes on the dividends they receive. The corporation pays tax on its profit. This is sometimes called double taxation because the owners pay twice — for dividends and for the corporation.
Do I Need an Attorney to Set up the Business?
If your business is a sole proprietorship, you don't need an attorney to set it up. All the other business forms require state registration and other agreements and legal processes. It's usually a good idea to get some help from an attorney, to be sure everything is done correctly.
What Is My Liability as a Business Owner?
As a sole proprietor, you will have all of the business liability for bad debts of the business, as well as for other liabilities, such as for negligence, product liability, or professional liability. You can limit your liability by setting up an LLC or, even better, by forming a corporation. Because the corporation or LLC is a separate entity from your personal financial life, you may be shielded personally from the liability of the corporation. This is a tricky area, so make sure you understand your personal liability in each of these forms of business. Find out more from your attorney before you make a decision.
In the end, whatever factors are most important to you will determine the form of business ownership you choose. You may decide to give up control to limit liability, or you may want the benefit of others helping you run the business.
The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.