Among the many other decisions new business owners must make, they also need to choose a business structure or entity. There are several different types of business structures, each of which affects essential aspects of your commercial enterprise.
Choosing the wrong business entity can leave you personally vulnerable to costly lawsuits. It can also cause your tax obligation to increase, thereby adding unnecessary expenses. Here are three questions to ask yourself when evaluating different structures and their benefits.
What is my budget for administration costs?
While cost should not be the only consideration you make, you want to ensure your business is capable of covering administration expenses well into the future. Corporations, which are their own legal entities, are costlier to start up and maintain. The numerous reporting requirements naturally take up more time and resources when compared to a sole proprietorship, which has relatively few reporting requirements and much simpler tax prep processes.
How do I want my business to be taxed?
Corporations are subject to what is known as double taxation, as they are taxed both at the individual shareholder level and at the corporate level. S corporations are an exception, as income and losses can be “passed through” to the shareholder’s individual returns. This is also how sole proprietorships and partnerships handle taxes. All income and losses are included in personal tax returns because the business is not a separate legal entity.
What risks does my business face?
While a corporation has higher operational and tax costs, it also safeguards owners against personal liability. With a sole proprietorship or partnership, your personal assets can be sought for damages from lawsuits originating with your business. Consider the likelihood that your business will be subject to a lawsuit in the future. Now consider the maximum cost this lawsuit could potentially incur. If the estimate is well above your financial ability, it may be worth the added time and money to incorporate.
You may also consider forming a limited liability company (LLC) if you are concerned about litigation. LLCs offer personal liability protection of corporations combined with the tax benefits of sole proprietorships and partnerships. And unlike S corporations, which are only available to businesses with 100 or fewer shareholders, an LLC can have any number of shareholders with an interest in the business.