What Is The Best Way To Form Your Business When You Are Self-Employed?

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Business Formation Options When You Own Your Own Business

When you are self-employed or have some other sort of small business, what is the best way to structure your business? You have four options: It can be a sole proprietorship, a partnership, some type of corporation, or a limited liability company (LLC).

Among other things, the problem with sole proprietorships is the personal liability that comes with that business form

Sole Proprietorships: A sole proprietorship is the easiest and cheapest form of business you can start. Simply name the business, get a business license, publish a fictitious business name statement in the local paper, and you are in business. It should cost about $100 to start a sole proprietorship. Although sole proprietorships are inexpensive and easy to create, and common for the self-employed, the bad news is two-fold:

  1. You and the business are one in the same; if something goes wrong, you are personally liable
  2. All business profits and losses become yours personally and are part of your individual tax return

Partnerships: A business partnership is akin to a marriage. Because partners will be spending a lot of time together, making both joint and individual decisions that will affect the partnership, as well as being together in both good times and bad, you need to think very carefully about whether you in actuality want a partner, and if so, who.

Like a sole proprietorship, with a partnership you become personally liable for business debts and liabilities. Moreover, because either partner can get the whole partnership into debt, your potential liability is double. There is the possibility that your partner can make some poor decisions, get the partnership into debt, and again, you will be personally responsible for that debt.

You must also think about the emotional aspect of having a partner. Do you really want one? Are you able to share authority? When you are a sole proprietor, you are the boss, but having a partner means you will have a partner. And remember, partnerships do not always work out – best friends who become partners do not always stay best friends. On the other hand, a partner gives you someone with whom to work, share ideas and brainstorm. Also, a partner is also another pair of hands to do the work.

So the important thing is to consider carefully the pros and cons of having a partner, and then, should you decide that the benefits outweigh the burdens, to find someone with whom you could work well.

Corporations and Limited Liability Companies (LLCs): As you can see, the problem with partnerships and sole proprietorships is the personal liability that comes with those  business forms. These entities do not protect you from business debts. But corporations and LLCs are different. In fact, one of the chief reasons to incorporate is to legally shelter your personal assets from business debts.

There are several types of corporations. The main two are S and C Corporations (S and C are subsections of the IRS Code.). While there are several differences between the S and C corporations:

  • C corporations are taxed twice: Once when profits are realized, and secondly, when those profits are passed onto the shareholders. S corporations pay no corporate taxes, instead, profits and losses flow through to individual tax returns.
  • C corporations are often large, publicly traded businesses. When you see a business whose shares are bought and sold on the NASDAQ, that is a C corporation. In fact, the ability to freely sell shares is one of the main advantages of a C corporation. S corporations are, generally speaking, intended for and used by smaller businesses.

Limited liability companies (or LLCs) are a hybrid, combining the best of corporations, sole proprietorships, and partnerships, and have become very popular. First, LLCs protect their owners from personal liability for business indebtedness. Second, LLCs are fairly informal – they are easy to create, inexpensive (the filing fee with your state will likely be less than if you started a corporation), and can be formed with only one member (unlike a corporation that requires officers and a board of directors.)

Which type of business structure is best for you? The best answer is to discuss these options with your legal and tax advisors before making that decision.