Selecting the Right Business StructureLinda Jenkins, August 26 2016
DBA or S Corporation? Selecting the right structure for your company is one of those critical legal decisions that an owner should make when forming a business. It's important in a number of different ways. Your business structure will determine how much paperwork your company needs to generate for legalities, how much you will pay in taxes, and how much liability you will face personally.
This choice will also affect your ability to obtain sufficient funding. We've presented the most common structures below for your convenience.
Different Types of Business Structures
Four primary legal entities are available. Each of these is explained below.
Sole Proprietorship- By far the most popular type of entity, the sole proprietorship aka "doing business as" or DBA, involves ownership by one person. Since only one owner is involved, this is the simplest type of structure to set up and the easiest to maintain. Any liabilities, debts, and taxes are the sole responsibility of the owner.
Limited Liability Company- The Limited Liability Company, also referred to as a LLC, incorporates several aspects of both a partnership and corporation while being open to individuals as well. This is an attractive option since the owners of a LLC are shielded from any personal liability. In particular, the LLC is an attractive option for sole proprietors with high exposure to liability and it makes perfect sense for them to use this specific entity in order to protect themselves. For example, self-employed physical therapists are at greater risk for liability issues and therefore, they might want to select a LLC in order to protect their personal assets.
Partnership- A partnership is the term used to define a venture that involves two or more people who are responsible for operating a company. Typically, the partners reach an agreement on how the business will be run in all aspects. Not only do partners share in the profits, but also, they share in any liabilities or debts that accumulate as a direct result of ownership.
Corporation- The corporation is considered a separate legal entity in its own right. It includes privileges of its own that are separate from the privileges that the owner might have. It also has separate liability issues from its owners. This means that the owners are protected from liability issues resulting from business activity, and the corporation is solely responsible for taxes accruing in direct relation to this activity. The primary disadvantage of a corporation is that it can be expensive to create and run. Therefore, detailed record keeping is essential.
Within this entity, two options exist. The S corporation includes one level of taxation for the business, but it includes specific limitations as to the number of stockholders as well as the type of stockholders that can exist. The traditional C corporation involves double taxation, but it also includes a more flexible tax planning approach as well as the ability to shield its stockholders from tax liability.
Understanding the differences among the various types of structures is the first step in creating a successful business. The next step requires proper planning. As the company grows, it might be necessary to revisit the chosen structure and select another. In particular, a small business owner has the potential to move or transfer from a sole proprietorship to a partnership or LLC quite easily.
Important Aspects for Choosing the Best Entity for Your Needs
In order to make the right selection, it helps to understand the following five terms:
Legal Liability- The amount of legal liability facing a business suggests the need to incorporate it or form a LLC in order to protect the owner. Protection of personal assets is essential in the event that a judgment is issued against your company due to a lawsuit. However, the nature of the business must be taken into account since it might preclude the need to incorporate or form an LLC due to a low risk of liability. If you can afford the potential liability risk, then a sole proprietorship may be a reasonable choice. This is primarily due to the fact that lower levels of potential liability can often be covered by insurance.
Tax Implications- The tax implications vary depending on the type of structure selected. In fact, corporations have a greater number of tax options over partnerships or proprietorships. For example, owners of a corporation do not have to pay any personal income taxes on any profits that they do not get. Plus, they have a lower federal corporate income tax rate on the initial $75,000 of income received by the corporation. On the other hand, unincorporated businesses have a higher federal individual income tax rate on the same initial $75,000 of income. Moreover, the owners of an unincorporated business will also be required to pay income taxes on the net profits.
Expenses- The expenses attached to a startup vary a great deal, and depending on the type of structure that you select, special fees might also apply. Setting up a LLC or corporation involves filing fees for documents; they are more expensive to run since documentation and proper records must be maintained on a quarterly basis, special rules must be followed, and officers must be elected to run the company.
Individual Needs- Your specific needs should be carefully taken into consideration. Are you able to work with others? Do you need to maintain control in order to hold onto your sanity? Do you know what it is that you are looking to accomplish from running your business? Each of these questions should be carefully considered prior to making the decision as to which legal entity to set up.
Flexibility- Even though you might select the right type of structure at start-up, it is important to realize that flexibility should be part of the plan. As your business evolves, it might be necessary to transform from one type of entity to another.
Since no two businesses have the same needs and no two owners have the same expectations, finding the right structure isn't always easy. Nonetheless, help is available offline through attorneys and CPAs, and online through a wealth of information that will point you in the right direction.
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