Finding The Right Business Structure For Your Startup

When you start a new business, one of the first decisions you’ll have to make is how to structure your company. This choice can be critical to the future health of your business. Taking time up front to consider the pros and cons of each possible structure will likely save you many headaches in the future. In certain cases, it can mean the difference between your business’s success or failure.

Below you’ll find the upsides and downsides to some common business structures: Sole Proprietorships, LLCs, C-corporations, and S-corporations.

Sole Proprietorship

Upside:

  • Easy to Form – Sole Proprietorships are the easiest, most common, and least expensive business structure. A person is essentially a walking, talking sole proprietorship in waiting. All you need to do is sell something—a product, a service, anything—and boom … suddenly you’re a sole proprietor. Aside from obtaining any required business licenses, a Sole Proprietorship requires no paperwork and no filing fees.
  • Decision Making – As suggested by the name, you are the sole decision-maker. You run your business the way you want to run your business, and you don’t have to ask permission from anybody.
  • Taxes – The IRS doesn’t view your Sole Proprietorship as a separate tax entity, so there’s no special or additional tax paperwork. You’ll simply file your taxes on the same 1040 form as any other individual.

Downside:

  • Liability – The lack of separation between you and your business leaves you liable for all debts and legal claims against the business. You can even be responsible for your employees’ actions (if you have employees) while they are on the job.
  • Funding – Sole Proprietorships lack a specific structure for raising funds. You have no stock to sell, no set percentages to offer, and banks are often reluctant to offer loans to sole proprietors.

Limited Liability Company (LLC)

Upside:

  • Liability – The greatest benefit of an LLC is its liability protection. Without a lot of aggressive work in the courtroom, if your business is involved in a lawsuit or judgment, your personal assets will likely not be seized.
  • Paperwork – Compared to corporations, LLCs have far less paperwork. They are less formal and have fewer requirements regarding resolutions and meetings.
  • Taxes – Profit flows through the company and straight to the members. There are no separate corporate taxes and no additional tax documents because your earnings are reported on your personal tax return.

Downside:

  • Self-Employment Tax – Taxation is still simpler in an LLC than a corporation, but LLC members must pay non-deductible self-employment taxes (your share of Social Security and Medicare).
  • Treatment of Income – Regardless of whether a member’s share of the profits are distributed to him or her, that share of profits represents taxable income.
  • No Salary: LLC members cannot pay themselves ordinary wages.

C-Corporation

Upside:

  • Liability – Like LLCs, C-corporations are legally distinct from their owners. This separation creates liability protection. Although this asset protection is not bulletproof, business creditors cannot easily seize your personal assets to pay bad debt, and your personal assets are most likely safe from lawsuits against the corporation.
  • Funding – C-Corps benefit from multiple avenues through which to raise money. Stock can be sold, and many investors feel more secure investing in corporations because they are established business structures with a long legal history.
  • Employees – C-corporations can offer a range of benefits to employees that generally make working for the corporation more attractive than working for other business structures.
  • Keep Money In the Corporation – Although all corporations will pay their net income tax on net profits, those profits can be kept in the company without paying additional taxes on that money, which is attractive to those who want to build capital or otherwise invest in their company’s future.

Downside:

  • Double-Taxation – If a C-corp issues dividends, the money issued to shareholders gets taxed twice. First, the money gets taxed by paying corporate income taxes. Second, shareholders must pay individual income taxes on dividends.
  • Formality – C-corps’ formal requirements – with boards of directors, official meetings, annual reports, and sometimes byzantine federal and state requirements – can make them slow and cumbersome to operate. C-corps must file more paperwork than any other type of business structure.

S-Corporation

Upside:

  • Versatility – S-corporations combine features of the C-corp and the LLC. They are taxed as a pass-through entity like an LLC, but S-corp members are also required to pay themselves what the IRS calls “reasonable” wages. Both LLCs and C-corps can elect to be taxed as an S-corporation.
  • Taxation – When an S-corp shareholder is also an employee of the business, he or she pays employment tax only on wages. This is a subtle but important difference from the ordinary LLC. LLC members usually pay employment tax on the net income of the business. With S-corps, however, the remaining income gets paid to owner/employees as a distribution, so the member isn’t required to pay the 15.3% self-employment tax.

Downside:

  • Shareholder Limitations – S-corps are limited to 100 shareholders or less, and all shareholders must be US citizens. Corporations and partnerships cannot be shareholders. Additionally, S-corps can only issue one class of shares.
  • IRS Attention – With an S-corp, you may run the risk of greater scrutiny from the IRS at tax time, as some business owners in the past have tried to pay themselves low wages and take big dividend distributions to save money on taxes. If you do elect to be taxed as an S-corp, you’ll want to document the reasons behind the wage you decided to pay yourself.

By Drake Forester

NO COMMENTS

LEAVE A REPLY