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What Legal Structure is Right for My Business?

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What Legal Structure is Right for My Business?

One of the first decisions you will have to make as an entrepreneur is which legal structure best suits your business. Here, we lay out the five most common business structures and the pros and cons of each one. This business solution will surely help you choose what structure is right for you.

1. Sole Proprietorship
A sole proprietorship is a company that is managed by one owner. The owner and the company are recognized as one legal entity by the government. Therefore, the sole proprietor and business share legal liability. In addition, the business profits are passed through to the business owner and recorded in an individual tax return.

Pros:

  • inimal paperwork
  • Easy startup and maintenance
  • Low startup fees
  • Full control over company

Cons:

  • Extremely high personal liability
  • Hard to acquire capital since the sole proprietor cannot exchange stock for capital

2. Partnership
A partnership is much like a sole proprietorship, only it involves more than one person. The business profits are passed through to the individual and are taxed on the individual tax return.

Pros:

  • A variety of skills contributing to the business
  • Easy and inexpensive startup

Cons:

  • Looming disagreement/conflict
  • High personal liability
  • Shared profits
  • Full control over company is given up
  • Hard to acquire capital

3. C Corporation
In any corporation, whether it be a c corporation or s corporation, shareholders trade money for stock. But c corporations and s corporations differ in taxing processes. Instead of passing the profits through to the shareholders (like in an s corp, partnership, or sole proprietorship), c corps opt to be taxed on both individual and corporate incomes. This is sometimes referred to as “double taxation.”

Pros:

  • C corps have the most flexibility when it comes to issuing shares. Therefore venture capitalists and angel investors are more willing to invest with c corps than other types of businesses.
  • Limited personal liability
  • Unlimited number of shareholders

Cons:

  • Complicated taxes (may need to hire an attorney)
  • Double taxes

4. S Corporation
An S corporation provides entrepreneurs with the limited liability of a corporation plus the “pass through” taxation process of sole proprietors and partners.

Pros:

  • No “double tax”
  • Limited personal liability

Cons:

  • Only one class of stock
  • Limited shareholders (100 maximum)

5. Limited Liability Company
If your business will most likely engage in some sort of riskier activity (the use of hazardous materials, selling of edible goods, caring for children or animals, requiring injury-prone actions), you should opt for the LLC, which protects your personal assets from business debts and claims. There are no tax advantages (or disadvantages) to forming an LLC: LLCs with one owner file for taxes as a sole-proprietor, while LLCs with multiple owners file taxes as partnerships.

This is because the federal government does not identify LLC as a classification, so a member (and owner of an LLC) must file as a corporation, partnership, or sole proprietorship tax return. A Form 8832 is filed to establish a business classification. Owners of an LLC may also have to pay additional state taxes, or “franchise taxes,” in addition to the income tax.

Pros:

  • Flexibility of management/taxing structure
  • Limited personal liability

Cons:

  • ”Franchise taxes,” a tax solely required of LLCs
  • More difficult to raise capital due to nebulous legal structure

When choosing a business model, you will have to analyze if you need limited liability, if you will benefit from “pass through” taxing, and how much capital you will need from outside investors. If you can determine these characteristics of your company, choosing a legal structure will be a breeze.

James Kim is a writer for Choosewhat.com. ChooseWhat is a company that provides product reviews and test data for business services and products. Their goal is to help small companies make informed buying decisions on business solutions that help their business.

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