There are five different company structures that you can choose from. The first is the sole proprietorship, the second the partnership, the third the corporation, the fourth the S corporation and the fifth the LLC (limited liability company). When you want to start up your business, it is very important that you understand the differences between the five and to understand which one is right for you.
When beginning a business, you must decide what form of business entity to establish. Your form of business determines which income tax return form you have to file. The most common forms of business are the sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC) is a relatively new business structure allowed by state statute. Legal and tax considerations enter into selecting a business structure.
Sole Proprietorships
The sole proprietorship is the most commonly chosen structure when it comes to setting up a business. This is because it allows the entire business to be owned and run by a single person. There is no distinction, therefore, between the business and the owner itself. This also means that all profits are yours to keep, but you are also solely responsible for any losses, debts or liabilities you incur as a sole proprietorship.
You do not have to take any formal action to form a sole proprietorship. As long as you are the only owner, this status automatically comes from your business activities. In fact, you may already own one without knowing it. If you are a freelance writer, for example, you are a sole proprietor.
However, you do have to look into any licenses, permits and other legislation you have to comply with for your chosen industry.
Partnerships
The second option is to choose partnerships. Partnerships occur when more than a single individual starts up the business. There are two types of partnerships, which are the general partnership and the limited partnership.
In a general partnership, the partners manage the company and assume responsibility for the partnership’s debts and other obligations. A limited partnership has both general and limited partners. The general partners own and operate the business and assume liability for the partnership, while the limited partners serve as investors only; they have no control over the company and are not subject to the same liabilities as the general partners.
General partnerships, therefore, are usually the best option. They are much easier to set up and much easier to manage. The paperwork involved with limited partnerships is so complicated you are likely to need a lawyer to help you out.
Corporations
Corporations are different once again. They are not owned by a single person or a group of people, but rather they have shareholders.
The shares may be privately or closely held, or they may be offered for sale to the public (publicly held). Corporations are formed by submitting Articles of Incorporation to the state in which the corporation is doing business. Corporations are taxed separately from their owners at the corporate tax rate.
This means a corporation has to be listed so that the shares can be bought and sold and that they have to produce regular, public financial reports and so on. Corporations are also accountable to boards of investors.
S Corporations
S Corporations are generally seen as a better option to smaller businesses. This is because of some of the great tax benefits this type of structure offers, as well as the fact that those who start the business continue to have the same protection as those who would start a regular corporation.
Owners of S corporations who don’t have inventory can use the cash method of accounting, which is simpler than the accrual method. Under this method, income is taxable when received and expenses are deductible when paid. S corporations can also have up to 100 shareholders. This makes it possible to have more investors and thus attract more capital, tax experts maintain.
Naturally, there are downsides to having an S Corporation, just as there are downsides with any other type of structure. Here, the problem is mainly that there is a lot of paperwork and administration that has to be maintained, and that the legal and tax service costs are much higher.
Limited Liability Companies (LLCs)
Lastly, there is the LLC. This is actually a completely new type of business and people are still getting used to what this is, trying to find out whether or not it will work for them. The LLC is quite like a regular partnership. However, the difference is that every single partner holds full limited liability protection. In other words, if something goes wrong, none of the partners will be held personally responsible for this. However, and LLC has to stick to a few more official rules than what a partnership does.
The only real issue at the minute is that not all states agree on what an LLC is and what their rights are. This is why it is so important to do a decent amount of research before deciding to go for this particular business structure.
With any business structure, it is important to seek some legal and financial advise to ensure you go for the most suitable option for your particular situation. There are always pros and cons to any situation and you must weigh these up carefully before making a final decision. Each option has different rights and obligations and you have to make sure that you are able to meet all of these. One of the biggest things to think about is how much liability you are happy to take on yourself.
