If you have decided to start your own business, I say congratulations! You are going to begin a new journey that requires hard work, non-stop hustle, many sleepless nights, self-motivation, consistency, a lot of risks, and sacrifices.
When you decide to start your business, you will have to choose and decide on the legal structure of your business. This is one of the most important choices you will make when forming a new business which is also called business ownership structure or business form. When making your decision about your business structure, there are a few to choose from. However, you should have an understanding of what each term means before making the right decision for your business.
A sole proprietorship is easy to form and gives you complete control of your business. Sole proprietorships don’t produce a separate business entity. This means your business assets and liabilities are not separate from your personal assets and liabilities. You will be held responsible personally for the debts and obligations of your business. Sole proprietorships can be a good choice for low-risk businesses and owners who want to test their business idea before forming a more formal business.
This structure is created for two or more people who want to own a business together. There are two common kinds of partnerships which are limited partnerships (LP) and limited liability partnerships (LLP).
Limited partnerships have only one general partner with unlimited liability, and all other partners have limited liability. The partners with limited liability also have limited control over the company, which is documented in a partnership agreement. Profits are passed through to personal tax returns and the general partner without limited liability must also pay self-employment taxes.
Limited liability partnerships are similar to limited partnerships, but give limited liability to every owner. An LLP protects each partner from debts against the partnership, they won’t be responsible for the actions of other partners.
LIMITED LIABILITY COMPANY (LLC)
LLCs protect your personal liability such as your personal assets. Examples of your personal assets are your car, house, savings accounts, and so forth. Your personal assets won’t be at risk in case your LLC faces bankruptcy or lawsuits. Profits and losses can get passed through to your personal income without facing corporate taxes.
However, members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security. LLCs can be a good choice for medium- or higher-risk businesses, owners with significant personal assets they want protecting, and owners who want to pay a lower tax rate than they would with a corporation.
A corporation, sometimes called a C corp, is a legal entity that’s separate from its owners. Corporations can make a profit, be taxed, and can be held legally liable
Corporations offer the strongest protection to its owners from personal liability, but the cost to form a corporation is higher than other structures. Corporations also require more extensive record-keeping, operational processes, and reporting.
Unlike sole proprietors, partnerships, and LLCs, corporations pay income tax on their profits. In some cases, corporate profits are taxed twice. First, when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns. Corporations have a completely independent life separate from its shareholders. If a shareholder leaves the company or sells his or her shares, the C corp can continue doing business relatively undisturbed.
Corporations have an advantage when it comes to raising capital because they can raise funds through the sale of stock, which can also be a benefit in attracting employees. This is a good choice for medium or higher-risk businesses, businesses that need to raise money, and businesses that plan to “go public” or eventually be sold.
Nonprofit corporations are organized to do charity, education, religious, literary, or scientific work. Because their work benefits the public, nonprofits can receive tax-exempt status, meaning they don’t pay state or federal income taxes on any profits it makes.
Nonprofits must file with the IRS to get tax exemption, a different process from registering with your own state.
Nonprofit corporations need to follow organizational rules very similarly to a regular C corp. They also need to follow special rules about what they do with any profits they earn. For example, they can’t distribute profits to members or political campaigns.
Nonprofits are often called 501(c)(3) corporations, a reference to the section of the Internal Revenue Code that is most commonly used to grant tax-exempt status.
Whatever you choose, be sure that the business structure it’s the right one for you. If you still need clarity or help in choosing your business structure, contact your local SCORE office where they can set up an appointment for you to be advised by an experienced mentor.