Depending on the type of small business you have, you’ve probably wondered a few times about the best way to set up the corporate and tax structure. To simplify, the three choices are to run your small business as a sole proprietor, an LLC, or Incorporate your business as an S or C corporation. Each structure has different advantages and disadvantages. Today I’ll walk through some of the early considerations that matter when choosing how to structure your business.
The easiest way to run your business is as a sole proprietor. A sole proprietor can be an individual or a husband and wife team. It is by far the simplest type of business because you don’t really need to do anything to set it up. For example, this blog is part of my sole proprietorship. The small amount of revenues I get from the advertising on this site is my income and my expenses are the hosting and software purchases that I make. I could name and register my business with the state if I wanted as a “dba” (doing business as) or get my sales tax license if I was selling finished goods, but in my case I didn’t do anything. At the end of the year I report the income and expenses on my personal tax return as a sole proprietorship. It’s that simple.
Simplicity and cost are definitely the biggest advantages of a sole proprietor and it works great for companies that don’t have much risk or that won’t grow too dramatically over time, but if you have a business that will have employees, multiple owners, or grow large over time, you should look at a more professional structure to your business.
Limited Liability Company (LLC)
A limited liability coompany, or LLC, is the next level higher for a business structure. In a limited liability company, the assets of the business are held in the LLC and the bottom line profit or loss is passed through to the owners of the LLC. The profit or loss is reported on the owners individual taxes. LLC statutes vary by state so you should check with the laws in your state before structuring your small business.
The key advantage of an LLC, as the name implies, is the limited liability. That means that if the company defaults on its debts or is involved in any kind of a lawsuit, that only the assets held in the company are at stake. This is key in protecting your personal assets while keeping them separate from the business assets.
There are a few other advantages too. For example, with an LLC you can have multiple owners. Also, taxes on an LLC are only taxed once at your personal income tax rate, as compared to a corporation that has its profits taxed twice. Also, an LLC is easier to set up than a corporation. That brings us to the most advanced way to set up your business – incorporating.
If your company is expected to grow rather large, or you are ever thinking about going public, you may want to consider incorporating. You can incorporate as either an S or C Corporation. Each has different advantages and by-laws, but generally speaking there are lots of extra costs and administrative duties associated with incorporating.
For starters, while you can form an LLC on your own, you will probably need legal help to set up a corporation. Also, corporations generally are required to provide shareholder meetings and form a board of directors to oversea the operations of the business. If you are still a small business, there are some shortcuts you can take to incorporate as simply as possible, but still allow for the type of control and growth that is offered with this method. If you think this might be the way to go, make sure and do more homework as to how to proceed.
Any thoughts about how to set up your small business? Please feel free to share.