Starting a Small Business

Plan Ahead by Choosing the Right Business Entity from the Start

Julie Farless

3/13/2016

Plan Ahead by Choosing the Right Business Entity from the Start

The legal structure of your business is about more than completing paperwork or simply satisfying a requirement – the structure you choose will impact your new company for years to come.

The business structure you choose matters every bit as much as the employees you hire, marketing methods you choose and even the decisions you make about your product or service itself. Each of the different types of structures has clear advantages and drawbacks, and the one you choose should closely align with your goals and needs as you move forward.

Business Structure Types

Learning more about the different types of business structures available to you can help you make the right decision for your company.

Sole Proprietorship: The most simple and common form of business; according to figures from the Small Business Administration, about 70% of all businesses in the United States are sole proprietorships. This form of business means that you are the sole owner and responsible for all aspects of company, including the profits and debts you incur.

Partnership: When you share the ownership of your business with one or more other individuals, you have a partnership. There are two types of partnership options: A general partnership allows you to share everything equally, while a limited partnership allows one partner to run the business while the other contributes assets or money and receives part of the profits the business earns.

Limited Liability Company: LLCs are state entities and not recognized by the IRS. For federal purposes the entity is either sole proprietorship, or partnership. This format allows you to run your business as you wish but protects your personal assets from debts or liabilities. If your business is sued, then an LLC can protect your personal income, property and assets; you are a distinct and different entity from the business itself. This hybrid format gives you all of the best parts of a sole proprietorship or partnership, combined with the protection afforded by a corporation. LLCs are state specific and if doing business in multiple states you would need multiple LLCs.

Corporation: There are several types of corporations and the one you choose will depend on your goals, investors and the size and scale of your plans. A corporation exists as an entity and can own property, sue or be sued, and sell stocks or rights of ownership to outside parties. C Corporations and S Corporations all offer different tax advantages and have different requirements for filing.

Things to Consider Before You Choose a Business Entity

The size of your business and number of employees you will eventually have matter, as do the amount of money needed for a startup, the potential risk of your venture and the growth potential. Take the following into consideration as you create your business and choose a structure:

Simplicity: If you have a low-risk business and want to keep things simple, then a sole proprietorship requires a minimal amount of paperwork and investment. It is a good idea to use an accountant to help you with your taxes, but your business can be covered in your annual tax returns each year.

Funding: If you need to borrow money or take on investors or partners, then a partnership or a corporation may be a better choice. The initial setup is a little more complex, but there are clear advantages to gaining more working capital and having clearly defined roles and responsibilities. However, many individuals shy away from partnerships for fear of being subject to another partner's actions and liabilities.

Liability and Risk: A corporation can give you the highest amount of personal protection from lawsuits and creditors. If you are concerned about liability, risk or eventual legal entanglements, then an LLC or corporation can protect your assets by separating you from the business.

Tax Differences: If you choose a sole proprietor, the income and deductions are included on your personal income tax return form 1040 and there is no need to file additional returns unless you also have an LLC for your business.

Both partnerships and S-Corporations are flow through entities, meaning you choose one of them, then your share of the profit or loss, capital gains, credits and other tax attributes flow through to your personal tax return. Of course, that requires the filing of an additional entity return. An accountant can help you file correctly and make sure you are truly getting all of the deductions and credits available to you.

Most state LLCs require a minimum payment for the year whether there was a profit or not. Consider that a payment for liability insurance and it is not so painful. However, LLCs are sole proprietors or partnerships for federal purposes and the profit or loss and other attributes are reported on your personal tax return. Your accountant may suggest quarterly or biannual advance payments to minimize the end effect on your return.

A corporation files its own tax return each year, paying tax on profits after expenses, including payroll. If you pay yourself from the corporation, you will have two options; take money out as a dividend, which is not deductible by the corporation, resulting in double taxation, or pay yourself a wage subject to payroll taxes, which must also be matched by the corporation. Thus, you cannot benefit from capital gains from the sale of a corporate asset. Another negative is when it comes time to sell your corporation many potential buyers will insist on an asset sale, denying you beneficial capital gains rates. This can be avoided if the buyer purchases your stock, but in doing so, the buyer is assuming your corporate entity, including all of its liabilities, which buyers would prefer to avoid. On the other hand if the corporation ends up going public there is an ongoing market for the shares.

No matter which entity type you choose, you'll need to set your new company up with all of the proper permits, licenses and registrations for your area. Learning more about your options can help you get your new business off to the best possible start and prevent problems in the future.

This summary is just an overview of your options. You should contact an accountant or attorney to discuss the appropriate legal entity for your business before establishing any of the entities suggested in this article.

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Julie Farless

Martinez & Shanken, PLLC is a Certified Public Accountant (CPA) firm based in Gilbert, Arizona. We provide a full range of accounting, bookkeeping, consulting, outsourcing and business services, but we specialize in tax preparation. We work with you to ensure that your personal or business processes are conducted in a manner that ensures ongoing integrity in your financial transactions. We are available to answer your questions and help with your ongoing tax planning and changing business needs.

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Liability Limitation and Usage Guidelines for TaxBuzz AI:
Limitation of Liability:

TaxBuzz AI is a tool designed to provide tax professionals with assistance in generating responses to tax research questions. While we strive to maintain the accuracy and reliability of the information provided, it is imperative to recognize that tax laws are dynamic and subject to change. Therefore, the use of TaxBuzz AI should be complemented by professional judgment and consultation with legal and tax experts.

By utilizing TaxBuzz AI, you acknowledge and agree that the information generated should not be considered as a substitute for professional advice tailored to your specific circumstances. We explicitly disclaim any liability for the consequences arising from the use of advice generated by TaxBuzz AI. Users are encouraged to independently verify the information and seek professional advice before making decisions based on the AI-generated responses.

Usage Guidelines:
- Professional Judgment: TaxBuzz AI is a tool to aid tax professionals in research and analysis. It is not a replacement for professional judgment, and users should exercise their expertise when interpreting and applying the information generated.
- Consultation with Experts: While TaxBuzz AI provides valuable insights, it is crucial to consult with legal and tax experts to ensure the advice aligns with the latest legal developments and specific nuances of a particular situation.
- Verification of Information: Users are responsible for independently verifying the information provided by TaxBuzz AI, especially in instances where the advice generated is critical to decision-making.
- Educational Purposes: TaxBuzz AI is intended for educational and informational purposes only. It is not intended to provide specific legal or tax advice tailored to individual circumstances.
- Non-Endorsement: The use of TaxBuzz AI does not constitute an endorsement or guarantee of the accuracy of the information provided. Users are encouraged to corroborate the advice with other reliable sources.
By accessing and using TaxBuzz AI, you agree to abide by these terms and acknowledge the limitations outlined herein. We reserve the right to modify these terms at any time, and your continued use of TaxBuzz AI constitutes acceptance of any such modifications. If you do not agree with these terms, please refrain from using TaxBuzz AI.

TaxBuzz.com is a service of CountingWorks, Inc., 2549 Eastbuff Drive., #448 208, Newport Beach, CA 92660

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