Whether you’re starting a new business or running an existing business, the business structure you choose for your company is crucial. Not only can your choice of business structure affect your taxes, but it could also affect your ability to let your company grow. Your structure can also have an effect on the level of paperwork that needs to be done within your business.
Regardless of the structure you have in place at the moment, you can still amend it to suit your own goals and aims for your business as required. Just be sure you understand the implications of this before you act. Speak to an accountant first, and be sure you notify the IRS and your state tax agency when you alter the structure of your business in any way.
So which structure is right for your business?
The sole proprietorship is the simplest structure of all. You’re the owner and the operator of the business, so all the decisions are yours to make alone. Your business turnover and expenses are included on your personal tax return, which can be great if you want to offset any income you earn from other sources.
Unfortunately, there are disadvantages to a sole proprietorship. Banks are often reticent about lending to sole proprietors, which can make it difficult to raise cash to expand and grow your business when you want to.
You will also find that you are personally liable for any debts the business has. If your business owes money to various creditors, they may be able to seize your personal assets. You are also risking your own assets if someone should file a legal claim against your business.
A partnership structure can have some advantages for those wanting more than one person to own and operate a business. The partnership itself does not pay any tax on the income it derives. Rather, it’s a ‘pass through’ structure, where the profits or losses made by the partnership pass through to the partners.
General partnerships are good for businesses where all the general partners own and operate the business. The partners are responsible for the business’s liability and they have control over the company.
Limited partnerships are more complex, in that limited partners have no control over the company and they don’t share the liability of the business. These structures are usually used for investors in the business only. They are also far more intensive to set up in terms of paperwork and administration.
A corporate structure is by far the more complex option. It’s also far more expensive than most of the other business structures. When you set up a corporate structure, it becomes an individual entity and must file its own separate tax return. It’s important to consider the differences in individual state corporation laws, as the regulations for different states will vary. Speak to an attorney regarding the implications of these.
The owner of an incorporated business isn’t held liable for the corporation’s debts, which can offer an extra level of asset protection to the owner. A corporation is also more easily able to raise funds than most other structures. This is because a corporation can sell shares of ownership, or stock, in the company to raise more money and increase business capital.
Corporations can also keep running indefinitely, even after the original owner dies, as the shares in the company can be passed down to other generations.
Unfortunately, the tax implications of a corporation can be considerable. Aside from the extra cost of accounting and tax preparation, corporations will need to pay corporate tax, as well as any state taxes due on the business earnings. On top of this, if you pay shareholders a dividend, these will be taxed as well at individual tax rates.
Choosing the Right Business Structure
Before you make a decision about which business structure you want for your business, there are some things you will need to address first.
Consider some of the following aspects that could affect your business, your personal assets and your individual liability levels:
1. Legal Liability
Will you need to insulate yourself against any legal liability for your business? This doesn’t just mean liability for any lawsuits that could be filed against your company. It also means liability for any debts the business may incur.
If you feel that your business is unlikely to get into debt with creditors or suppliers, or you feel that there’s an extremely low risk of litigation in your particular business, a sole proprietorship may be fine.
However if you feel there could be a risk involved, you will need to look into a structure that offers you greater protection.
2. Associated Costs
While there may be certain tax advantages to choosing some business structures over others, it’s important to consider the costs associated with running them too. You may find that the increased cost of setting up the structure, accounting costs, record keeping, administration and tax preparation costs with some structures may reduce the tax advantages you thought you were receiving.
3. Tax Implications
Think carefully about the tax implications of the structure you choose. It may seem as though a corporation offers more tax options, but there are also significant disadvantages to consider as well.
Changing Structure As Your Business Grows
Of course, if your business is still in the fledgling stage, you might want to test the waters and see how it performs under a simple sole proprietorship. You can always change the structure at a later point to include partners.
You might even incorporate the business to add a level of protection against liability, or become a corporation to help you raise the funds needed to cover the costs of expansion.
Regardless of which option you think you prefer, it’s still crucial that you speak to an accountant about the implications of your decision. Understand how your business income will be treated at tax time and what you need to do.
When you have all this information at hand, you’ll find it much easier to decide which business structure will be right for your needs.
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