This is among the most frequently asked questions when planning a new small business start-up. It’s also one of the most important ones to answer. The structure you choose will affect everything from paying taxes to assigning liability, from raising capital to sharing profits.
Each type of structure has trade-offs that should be fully understood. Here’s a quick comparison of those most frequently used by small businesses:
A sole proprietorship is an unincorporated business owned by one person. Paying taxes is relatively simple, as the owner reports income/losses along with his/her personal taxes. However, the owner is personally liable for any business-related expenses or liabilities. While there are no corporate registration requirements, sole proprietors may still have to comply with local registration and licensing laws.
In a partnership, two or more people share ownership. Each contributes time, resources, expertise, and/or money to the business in return for a share of the profits/losses. Each partner is also responsible for his/her own actions, as well as business debts and decisions made by other partners. That’s why a partnership agreement is a must. It should detail each participant’s contributions and responsibilities, division of profits, resolution of disputes, and the handling of other major business decisions.
Then there’s the corporation, an independent legal entity owned by shareholders. Corporations inherently have complex administrative, tax, and legal requirements. On the other hand, selling various types of shares in an established business can make it easier to raise capital. Plus, shareholders are not legally liable for the business’s actions and debts.
A variation of this structure is the “S corporation,” named for the Internal Revenue Service subchapter that defines it, and often used in situations where the shareholders are also employees. An S corporation distinguishes between shareholder/employee wages and other profit distributions, which are taxed at different rates. However, S corporations carry the same legal and administrative requirements of “regular” corporations.
The limited liability company (LLC) has become a popular structure for small businesses in recent years. LLCs offer a corporation’s limited liability with a partnership’s flexibility and simplified taxation. There are also fewer recordkeeping requirements, and it’s entirely up to the LLC’s owners (known officially as “members”) to determine profit distribution. However, LLC members must pay self-employment taxes and make their own Medicare and Social Security contributions. And when a member leaves, the LLC must be dissolved.
Each structure has provisions and options that require exploration before finding the right match for a small business. And the best place to get help with this decision—and any other small business issue—is SCORE. Dedicated to aiding both new and experienced entrepreneurs, SCORE offers valuable training resources, seminars, and network of more than 13,000 volunteers who provide free counseling at no charge.
For more information and help with your business structure questions, visit http://raleigh.score.org or call 919-856-4739 to arrange a mentoring session.