There are many different things that a person has to think about as a new business owner. For most small business owners, their company is their life and something that takes most of their time and energy. One of the most important components of beginning a new venture is to consider what the organizational structure of the business will be.
You already know what goods or services your company will offer and what makes you stand out from the rest, so now it is time to get into the nitty-gritty of business structures. This article will help give the basic information required to get started, from what the main types are to the best choice for you and your new business.
What is a business structure?
The structure that your business takes will determine how the company is taxed and what it will be legally allowed to do. This is why it is so important to carefully consider the ramifications of your choice and pick the option that will benefit your company the best in the long run. We will go into greater detail about the four main kinds of business structures that most people choose, but here is a brief list to help give you some important background information:
- Sole Proprietorship
- General Partnership
- Limited Liability Company (LLC)
Do not make your decision lightly. Make sure that you are using all available resources to help guide you in the right direction, such as legal and financial advisors. They will ask you questions about your current circumstances, your future goals and other important considerations.
The four business structure types
Now it’s time to get a general idea about what the four types of business structures are. Each one has its own advantages and disadvantages, and some have a greater impact than others on your particular situation.
1. Sole proprietorship
A sole proprietor business structure is most popular for small businesses because there is no legal distinction between the owner of the company and the company itself. For tax purposes, the business organization itself does not file the return. Instead, it is done through the owner’s personal income tax. While this holds many benefits, the small business owner or sole proprietors does become exposed to higher risk when compared to the other kinds of structures due to the owner having unlimited liability.
2. General Partnership
In a general partnership, two or more people have control of the business. Because of the nature of having more than one person in charge, a general partnership will provide a framework for the collaboration by standardizing rules for profit and loss sharing, other percentages, dissolution terms, and management rights. Each owner is liable and at risk with this kind of structure. When filing taxes, use the annual information return in Form 1065 to report income. Keep in mind that income taxes are dependent on each partner’s share of the profits and losses.
3. Professional Limited Liability Company (LLC)
Similar to a general partnership, this structure is used when there is more than one owner, usually referred to as members. The difference between the two is that an LLC will protect the owners from personal liability for business entity debts and claims. As far as taxes are concerned, the internal revenue service (IRS) uses what is called a “pass-through entity,” similar to a partnership.
There are two kinds of corporations, a C corporation and an S corporation option. In this business structure, a corporation is basically a legal entity that has nothing to do with the owners and shareholders of the company. The two kinds of corporations are broken up for tax purposes. A C-Corp uses Form 1120 for federal income purposes, enabling the entity to file its own tax returns. On the other hand, an S-Corp passes its income and losses through the owner’s own taxes. The taxes that the business does file must use Form 1120S. Even within this business entity structure, there are different ways to break it down, such as a nonprofit corporation.
Which is best for a small business owner?
Small businesses are usually encouraged to start with the sole proprietorship business structure, especially if there is only one owner. Corporations are usually reserved for companies that are well established and large enough to have many shareholders. A sole proprietorship is a good option for a single owner because you don’t have to take many steps to form the business. According to the IRS, “As long as you are the only owner, this status automatically comes from your business activities.”
This kind of business and legal structure gives you complete control over your business and gives you the power to make the choices you need to without being concerned with obligations to others. The tax form is easy to get and simple to fill out. If there are two owners, consider creating a general partnership. Keep in mind that the owner or owners must shoulder the responsibility of being liable for losses and damages as the sole owner of the business. Your personal assets could be vulnerable.
Advantages and disadvantages
There are several advantages and disadvantages that can be found with each kind of business structure. It really depends on each business owner’s circumstances. As previously mentioned, a corporation is not the best structure for a small company with no shareholders or even one shareholder.
On the other hand, a corporation is ideal for a large, well-established business with plenty of shareholders or owners. It protects the owners from liability, which is a great advantage. Because of the variable nature of business structures, it is important to speak with a professional who can guide you in the right direction. Every situation is different, which is why advice from knowledgeable people is extremely important.
To learn more about how your business structure can impact your personal and professional finances, reach out to Bank Midwest today.