Starting a business is an exciting process, but there is no doubt that a lot of information can quickly overwhelm business owners. In the first steps of getting started, registering your business as a legal entity is required, but with multiple options available, knowing which is right for your business isn’t always easy.
When it comes to legal structures, there are some essential things to keep in mind.
- Who is all involved in the ownership of the business?
- How do you see the company growing down the line?
- How will taxes come into play?
The type of business entity and filing status that you choose will depend on three primary factors: liability, taxation, and record-keeping.
Here’s a high-level overview of the differences between the four most common forms of legal structures you can choose from.
Types of Business Entities
A Sole Proprietorship
A sole proprietorship is the most basic and common form of business entity. A sole prop is easy to form and offers complete managerial control to the owner of the business. However, that owner is also personally liable for all financial obligations of the business.
If you’re the only business owner and you’re just getting started with a smaller business, this is a great option for you.
A partnership business involves two or more individuals who agree to share in the profits or losses of a business. Profits or losses get “passed through” to partners to report on their individual income tax returns, so the entity does not bear the burden.
The main disadvantage of a partnership is the liability: each partner is personally liable for the financial obligations of the business.
For businesses involving two or more owners, a partnership can be a great place to start. However, if you need to avoid personal liability, the next business structure may be a better fit.
A corporation is an entity that is created to conduct business, separate from those who founded it. The business entity handles the organization’s responsibilities. Similar to a person, the corporation can be taxed, can be held legally liable for its actions, and can also make a profit.
The biggest advantage to a corporate status is the avoidance of personal liability. However, the cost to form a corporation and the extensive record-keeping that’s required prevent some businesses from reaching this status.
A Limited Liability Company
A hybrid form of a partnership, the limited liability company (LLC) status is gaining in popularity. An LLC allows owners to take advantage of the benefits of both the corporation and partnership forms of business entities.
This means that profits and losses can be passed through to owners without taxation of the business itself, while owners are also shielded from personal liability.
Still have questions? We have answers.
If you have other questions about which structure is best for you, contact us! We recommend talking to a professional like our team at Gift CPAs to learn more about each type and how a certain filing status can influence your business down the line. Schedule your appointment with our team today.