When you’re starting a new business, you probably want to be sure that you’re starting off on the right foot. Part of that means making sure you’re choosing the right kind of structure for your business. The type of business entity you choose for your company will have important ramifications for how much personal liability you assume for your company’s debts and how your company is taxed.
Businesses are formed from four basic types of organization:
- Sole Proprietorships
- Limited Liability Companies
These four business structures can be tweaked to optimize how the company is exposed to taxation or the amount of liability a business owner may have for his or her company debts. That said, it’s important to have a grasp of how each type of business is different from the next.
Sole proprietorships are popular for new business owners who are working alone. These types of businesses are unique in that no actual business entity needs to be formed because the business is legally indistinguishable from its owner. Instead, the business owner will have to select a “doing business as” name to signal their business operations.
Because there is no legal distinction between the company and its owner, however, this means that someone’s business debts and personal debts are one and the same. In other words, there is no liability protection for a sole proprietor – unless they choose to reorganize their business with a different structure. There is also no distinction between someone’s personal income and business income for taxation purposes.
When two or more people choose to go into business together, they might choose to organize their company as a partnership. Under this business structure, partners commonly enter into an agreement where the division of their company’s responsibilities, profits, and liabilities are clearly outlined. This means that a partner could be held accountable for his or her share of the company’s debts, but he or she can also benefit greatly from its profits. Any profits a partner earns are also taxed to him or her individually.
Limited Liability Companies (LLCs)
A limited liability company is so-named because its members’ (owners’) personal liability for the company’s debts is limited. This means that if an individual sues an LLC or otherwise trying to collect a debt, it can only go after assets that the LLC owns. Without this level of liability protection, creditors could go after the personal assets of the LLC’s members. As far as taxation is concerned, LLC owners are taxed individually and their earnings are subject to self-employment taxes.
Corporations can nearly completely shield their shareholders against personal liability unless they’ve personally guaranteed a business debt. This type of business is formed as a separate legal entity that does business in its own name and files its own income tax returns.
A variation of this type of organization, called a Subchapter S election, allows shareholders to be individually taxed on their unique share of the corporation’s income. Subchapter S corporations can also avoid federal income taxation at the corporate level.
Do You Need Help Forming Your Business?
Whether you’re a new or experienced business owner, starting a new company can be an intricate process requiring precision and attention to detail. We at A. Singer & Associates, Inc. can walk you through this process and advise you on which type of business structure may be best suited for helping you achieve your long-term goals.