Choosing a Legal Structure

Choosing a legal structure is an important part of starting a business. Every business has to have one. Will yours be a sole proprietorship? A corporation? A partnership?

The structure you choose has many legal and financial implications, including who owns the business, how decisions are made, how profits and losses are shared, how you can raise capital, and how much you’ll pay in taxes.

The following provides a general overview of several of the most common business structures. Since the legal and tax aspects of business structures vary from state to state, it is advisable to seek the advice of local experts. We recommend talking with both a certified public accountant and attorney. They’ll help you understand all of the implications of your decision and may be able to suggest other structures for you to consider.

Sole Proprietorship

This is the most common business structure. It is also the easiest and most inexpensive to start. You do not need to establish a separate legal entity. In most cases, all you need to do to get started is open your doors for business. Some states may require a business license—check with your state and county authorities.

In a sole proprietorship, the individual entrepreneur is the sole owner. Income flows directly to the owner, who is responsible for reporting profits and expenses on their personal tax return, using a Schedule C. The main drawback is that the owner is personally and solely liable for all obligations and actions of the business.

While this is the most paperless form of business to start, there is still some unavoidable red tape. For example, you’ll need to keep track of your business expenses and segregate them from personal expenses. You’ll also be responsible for tax reporting and payments. If you plan to have employees you’ll need to apply for an employer identification number (EIN) from the IRS. And, if you plan to do business under a name other than your own, you’ll need to file a DBA (which stands for “Doing Business As….”) with your state or county authority.

Partnership

A partnership is like a sole proprietorship, but with more than one owner. Profits and losses from the business flow directly to the owners in proportion to their share of ownership. Partners share ownership, profits, losses, liability and control of the business and should also mutually contribute their services and assets to the business.

Corporation

A corporation is a separate legal entity with a life of its own. Corporations are owned by shareholders whose liability is (for the most part) limited to the assets of the company. To start a corporation you must file incorporation papers, pay a filing fee, and issue stock.

This is the most expensive and complicated form of business to start. Corporations are also more heavily taxed than other business structures. Profits are taxed twice—the corporation pays taxes of profits and shareholders pay taxes on dividends. These drawbacks are often offset by the benefits of limited liability and the ability to raise capital by selling stock. Most large companies prefer corporations.

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