Starting Your Own Business – what Legal Form Should It be?

  • Print Article |
  • Send to a Friend |
  • |
  • Add to Google |

So, you have decided to start a new business venture. Congratulations. You have plenty of decisions to make as to how to set the business up. But you will get there for you are going to build the better mousetrap.

One decision that you have is what legal form to establish for the business. Are you going to incorporate? Seem like you have heard about something called an LLC, what is that? Or are you just going to hang out a shingle as "doing business as" (d/b/a).

Today, let's deal with the tax and some legal aspects of each choice. Let's look at the choices and the tradeoffs of each choice. Let's focus on three of the more popular choices for the small business:

  •  The sole proprietor (d/b/a)
  • The Limited Liability Company (LLC)
  • The S-Corporation

Each choice has its advantages and disadvantages. And depending on your situation, there may be other choices which will suit your needs.

The Sole Proprietor - This is the simplest form of business and the least expensive initially. This involves one owner doing business on their own account or storefront. It does not really require any setup or planning, just hanging out a shingle. Many businesses start off as a sole proprietor even if they move to something else later. Losses will offset other income because the income and expenses are recorded on the personal return. Disadvantages include unlimited liability and full exposure to self employment tax.

The Limited Liability Company - This is similar to a partnership or a sole proprietorship except that it offers limited liability for the members. One advantage is the flexibility in the structure for multiple owners. It does carry a cost of a formal legal organization similar to a corporation. A single member LLC is taxed similar to a sole proprietor. A multi-member LLC files a partnership return. Income is passed through to the owners and tax is paid on the personal return, resulting in no double-taxation. However, in most cases, the earnings are taxed with self-employment tax. An LLC can be an excellent choice for holding and operating real estate, such as renting a commercial building to you or to others.

The S-Corporation - This is a corporation in every aspect except how it is taxed. There is a certain amount of legal structure to this type of entity. Shareholders elect to be taxed on their personal return and the corporation, generally, pays no tax. This eliminates the double taxation at the corporate and personal level.

There is limited liability protection the same as an LLC or other corporation. One advantage is the limitation of payroll taxes. Reasonable salary and compensation is established for the owner / employees and payroll taxes are paid on this amount. Any amount of profits after a reasonable salary is paid is taxed as distributions to the shareholders. There is a limit of 75 shareholders to the S Corporation. Losses flow through to the shareholders as well.

As you can tell there is no one-size fits all answer. It depends on the business, its owners, the amount of income expected and what they are trying to accomplish. This gives you a brief overview of the tax consideration and the basics of each choice of entity.

This article explains the basics regarding the choice of entity. It is not intended to render legal, accounting or tax advice. It is advised to seek out competent legal and tax advice when making this decision.

Phil Bailey is CPA - Your trusted tax adviser helping small businesses to comply with tax laws since Georgia since 1983. Please follow me on Twitter at www.twitter.com/epbaileycpa. For more information please visit www.EPBaileyCPA.com

Rate this Article:
  • Article Word Count: 566
  • |
  • Total Views: 140
  • |
  • permalink
  • Print Article |
  • Send to a Friend |
  • |
  • Add to Google |
>