Finding a Business Structure for a Small Business

If you are still in the planning stages of starting a business, you will need to figure out what the best business structure is for you. There are advantages and disadvantages to each. In this article we’ll look at the major types and talk about why one or another may be right for you.

Each business type is designed to provide certain advantages to the business owners, depending on the situation. Let’s look at each of the five business structures and see which one is right for you.

Sole Proprietorships:

A sole proprietorship is the simplest type of business to start. It is owned by one person and from a taxation perspective it is no different than that person; that means the income and taxes of the business are the income and taxes of the individual. All assets are held in the name of the owner. If your business succeeds, all of the profit is yours; if the business fails, all of the liability is yours as well.

Advantages: These are easy to start and easy to manage. You get all of the profits.

Disadvantages: You have full financial liability. You cannot pass this business on to your children.

Partnerships:

A partnership is a business agreement between two or more people. Each person can contribute various resources (such as money, assets, or labor) to the business and each person shares in the business’ profits and losses. When it comes to taxes, the partnership fills out a tax return separately from the individuals to report income and loss. However, a partnership does not pay any tax. Instead, each partner reports their own share of the income or loss on their own personal tax return and pay taxes off of that.

Advantages: You can share responsibilities with people whose skills complement your own. You have access to more income and losses are spread out.

Disadvantages: Disagreements between partners can cause problems. You cannot pass the business on to your children. You have to share the profits.

Corporation:

In a sole proprietorship or partnership, the people involved own the business. In a corporation, people own shares that represent a portion of the business. Any profit earned from the corporation is paid out in dividends to the shareholders. From a tax perspective, a corporation is its own entity, meaning tax returns are filed and the corporation is taxed on its own rather than passing the taxation on to the individual, like in a partnership. Because a corporation is considered a separate entity, if it fails, the corporation is folded up. (Compare that to a sole proprietorship: because it is considered the same as the owner, if the business fails, all of the liability is yours as well.

Advantages: Limited liability; if the business fails, you are not financially ruined. Large size provides opportunity for economy of scale, broad financial resources and cost spreading. You can pass the shares on to your children.

Disadvantages: These are difficult and expensive to form. Many people may be involved. Heavily taxed.

S Corporations and Limited Liability Companies (LLC):

These are two additional types of businesses that have similarities to those already mentioned. Both are somewhat similar to a cross between a partnership and a corporation. S Corporations avoid double taxation (the corporation being taxed on income and the shareholder being taxed on dividends) and LLC structured businesses limit personal liability like a corporation but pass through taxation like a partnership.

Ultimately, while you’re in the business planning stages, you’ll want to consult an attorney on this to make sure that you are choosing the best business model for you.

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