Which Legal Structure Is the Right Fit For Your Business
KNOW WHAT STRUCTURE TO CHOOSE WHEN FORMING YOUR BUSINESS
One of the first things you’ll need to do when creating a business is to choose the right legal structure for it. This decision has many ramifications. On a federal level, your company’s legal structure (also known as a business entity) will determine your tax burden. On a state level, it will determine how much liability your company will face during a lawsuit.
Not sure which legal structure to choose? Here are your main choices and the key factors each of them will have on your future plans.
Types of Legal Structures
In general, there are four legal structures you need to be familiar with. They include sole proprietorship, partnership, limited liability company (LLC), and corporation.
Sole Proprietorship
A sole proprietorship is the simplest type of business for a solo entrepreneur or a couple that doesn’t have employees. You don’t need to do much to set one up and you’ll report your income on your personal tax return. The downside is that sole proprietors aren’t legally separate from their businesses, which makes them liable for their business obligations.
Partnership
A partnership is an incorporated business owned by two or more owners. The owners share all business profits and report them on their tax returns. A partnership can be general (no protection against liability for your partner’s misconduct) or limited (your liability is limited to the amount you invested in the business).
Limited Liability Company
A limited liability company (LLC) provides protection against liability for all its members. If your LLC can’t pay its debts, only its business assets – and not the members’ personal assets – will be at risk of a lawsuit. That said, LLCs may not be the right choice if you’re seeking venture capital or plan on becoming a publicly-traded company.
Corporation
Corporations offer the same liability protection as LLCs, but they have slightly more complex record keeping and reporting requirements. A corporation can be taxed as a C Corp or S Corp. C Corps pay corporate income tax, and their members also pay taxes on money they bring home. With S Corps, all business income flows through to shareholders’ personal returns.
Choosing Your Legal Structure
The first factor in choosing a legal structure is your tolerance for risk to personal assets. Whereas LLCs and corporations protect your personal assets, the same can’t be said for sole proprietorships and general partnerships. Limited partnerships are a bit different since limited partners are only liable for the amount of their investment.
Next, how much administrative complexity can you handle? For non-corporation structures, paperwork tends to be light and doesn’t require special expertise. Most ongoing requirements come on an annual basis. The administrative complexity increases at the corporation level, so you’ll likely need a lawyer and an accountant.
Finally, what are your long-term business goals? If you’re interested in fast growth, for example, C Corps don’t restrict the number of shareholders and allow for various cases of stock. That makes them the best fit if you’re looking to become a publicly traded company.