Choose the Best Legal Structure for Your Business

The legal framework of your company has a lot of implications. It can establish the extent of legal exposure that your business will incur. It can create a barrier or make sure there isn't one between your personal and business taxes. It can also decide whether you even need a board of directors and how frequently your board of directors must file documentation. [Related article: How to Respond to a Lawsuit Against Your Company]

We'll talk about business legal structures and how to pick the best kind for your company.

What Is A Business Legal Structure?

A business entity, sometimes referred to as a business legal structure, is a categorization issued by the government that governs specific areas of your company. Your business's legal form affects your tax liability at the federal level. It may have consequences for responsibility at the state level.

Why is a business legal structure important?

One of the most important decisions you will ever make is selecting the appropriate business structure from the outset. Here are some things to think about:

• Taxes: The income from their businesses is classified as personal income by sole proprietors, partnership owners, and S corporation owners. Income received by a C corporation is distinct from an owner's personal income. Your decision about your structure might have a big influence on your tax burden because business and personal incomes are taxed at different rates.

• Liability: In the event of a lawsuit, your personal assets may be shielded by limited liability company (LLC) arrangements. Nevertheless, LLC structures are only recognized at the state level; the federal government does not recognize them. The liability protection of LLCs is included in the federal corporate structure known as C corporations.

• Paperwork: There are specific tax forms for every firm legal structure. In addition, if your business is organized as a corporation, you'll have to file specific government reports on a regular basis and submit articles of incorporation. You will also need to complete additional papers if you form a business partnership and operate under a false name.

• Hierarchy: A board of directors is a requirement for corporations. This board is required by some states to convene a specific number of times annually. Corporate hierarchies help shield businesses from closing down in the event that a founder passes away or transfers ownership of the company. This closing protection is absent from other buildings.

• Registration: In order to register your business in your state, you must also have a business legal framework. Without a business structure, you cannot apply for a license, permit, employment identification number (EIN), or any other necessary authorization.

• Fundraising: There are various ways in which your structure may prevent you from raising money. Sole proprietorships, for instance, are typically unable to provide stocks. Corporations are the primary holders of that right.

• Possible repercussions for selecting the incorrect structure: Even though you can modify it later, the business structure you choose at first is quite important. But altering your company's structure can be a disjointed, perplexing procedure that might have unanticipated tax repercussions and cause your company to dissolve without warning.

Types Of Business Structures

Sole proprietorships, partnerships, corporations, limited liability companies, and cooperatives are the most prevalent forms of business entities. Here's more information about every kind of legal framework.

Sole Proprietorship

As a business entity, a sole proprietorship is the most basic. A sole proprietorship places all of the financial obligations and earnings of the business on one person.

"A sole proprietorship allows you to be in complete control if you want to be your own boss and run a business from home without a physical storefront," stated Deborah Sweeney, vice president and general manager of Deluxe Corp.'s business acquisitions. "This company does not provide for the protection or division of personal and professional assets, which may be a problem if your firm expands and more facets come under your purview.”

Costs of proprietorship differ by market. Early costs typically consist of taxes, state and federal fees, office space, business equipment leasing, bank fees, and any professional services your company hires. These companies include, among others, freelance writers, teachers, bookkeepers, cleaners, and babysitters.

There Are Various Benefits To A Sole Proprietorship Business Form

• Simple setup: The easiest legal structure to set up is a sole proprietorship. This could be the ideal structure if you and you alone are the owners of your company. Since you don't have executive boards or partners, there is relatively little paperwork.

• Low price: State-specific costs differ, but in general, the only expenses related to a proprietorship are license fees and business taxes.

• Tax deduction: Because your firm and you are one and the same, you could qualify for certain business sole proprietor tax deductions, like the deduction for health insurance.

• Simple departure: Establishing and dissolving a proprietorship are simple processes. If you're the only owner, you can close your company whenever you choose without having to file any official documents. For instance, if you open a daycare center and decide to close it down, you shouldn't run the daycare and promote your services.

• One of the most popular legal forms for small businesses is the single proprietorship. Numerous well-known organizations began as sole proprietorships before expanding to become multimillion dollar enterprises. Here are a few instances:

Partnerships In Business Provide Several Benefits

• Simple formation: A business partnership requires less paperwork to be filed than a single proprietorship. Should your state mandate that you conduct business under a false name, often known as "doing business as," or DBA, you will have to pay extra fees to file a Certificate of Conducting Business as Partners and write an Articles of Partnership agreement. Typically, a business license is also required.

• Possibility of growth: With several owners, your chances of getting a business financing are higher. If you have a subpar credit score, bankers may take into account two credit histories rather than just one.

• Particular taxes: Although general partnerships typically do not pay income tax, they are required to file state and federal tax filings on Form 1065. On their individual income tax forms, each partner discloses their portion of the income or loss. For instance, you and your friend would be co-owners of the company if you established a general partnership and founded a bakery together. Every owner contributes a particular amount of working capital and experience to the company, which has an impact on each partner's business share and contribution. You and your company partner may decide that you will keep a larger share percentage, making you the majority owner, if you contributed the most seed money to the venture.

• One of the most popular company arrangements is the partnership. Here are a few instances of fruitful collaborations:

Limited Liability Company

With the tax and flexibility advantages of a partnership, owners, partners, or shareholders can restrict their personal liability by forming a limited liability corporation (LLC), a hybrid structure. If it cannot be demonstrated that an LLC member acted carelessly or improperly, causing harm to another person while conducting business, then the member is exempt from personal accountability for the debts of the company.

According to Brian Cairns, CEO of ProStrategix Consulting, "limited liability companies were created to provide business owners the liability protection that corporations enjoy while allowing earnings and losses to pass through to the owners as income on their personal tax returns." "Profits and losses do not have to be distributed equally among members; LLCs may have one or more members."

Depending on your state, the state filing fee is included in the cost of incorporating an LLC. For instance, in order to register an LLC in New York, you have to pay the New York Department of State $200 in filing fees, $9 in biannual fees, and a biennial statement.

LLCs are a viable legal form for small enterprises, but some large businesses prefer another option. Other kinds of businesses also file as LLCs, but accounting, tax, and legal firms typically choose this structure. One of the top companies in the American beer market, Anheuser-Busch, is an example of an LLC. Anheuser-Busch, a multinational brewing firm with its headquarters located in Leuven, Belgium, is a wholly owned subsidiary of Anheuser-Busch InBev, a company established in St. Louis.

Here are a few more well-known LLC examples:

• Coca-Cola

• Nike Sony Hertz Rent-a-Car eBay IBM

Read Also: Process of Obtaining a Women's Small Business Grant

Factors To Consider Before Choosing A Business Structure

Selecting a structure might be difficult for new companies that potentially fit into two or more of these categories. Examine the risk, growth potential, and financing requirements of your startup. Give careful consideration to your legal structure in the early phases of business formation, as it might be difficult to change once your company is registered.

These are some important things to think about while selecting the legal structure for your company. For assistance, you ought to speak with a CPA as well.

Flexibility

What direction is your business going, and what kind of legal structure will enable the expansion you hope to achieve? Consult your company strategy to evaluate your objectives and choose which structure best fits them. Your organization should encourage growth and change rather than preventing it from reaching its full potential. [Use this template to learn how to build a business plan.

Complexity

A sole proprietorship is the most simple business structure in terms of startup and operating difficulty. Get your name registered, get your business going, declare the profits, and pay personal income taxes on them. However, obtaining outside finance may not always be easy. In contrast, a formal agreement outlining the roles and profit sharing percentages is necessary for partnerships. There are different reporting obligations for corporations and LLCs from both the federal and state governments.

Liability

Since a company is considered to be an independent legal body, it is subject to the least level of personal liability. This implies that although creditors and clients may file a lawsuit against the company, they will not be able to seize any of the executives' or shareholders' private property. The same security is provided by an LLC, together with the tax advantages of a sole proprietorship. According to the terms of a partnership agreement, partners in a partnership share liability.

Taxes

An LLC owner is subject to the same taxation as a sole proprietor: at the end of the year, all profits are taxed as personal income.

"You want to avoid double taxation as a small business owner in the early stages," Rivetr principal Jennifer Friedman stated. "That is avoided by the LLC structure, which ensures that you pay taxes as an individual rather than as a company."

Partners in a partnership may additionally deduct their own income from their portion of the earnings. Quarterly or biannual advance payments could be recommended by your accountant to reduce the impact on your tax return.

Every year, a corporation files its own tax returns and pays taxes on its profits after deducting payroll and other costs. You will pay personal taxes on your personal return, including Social Security and Medicare taxes, if you get compensation from the corporation.

Capital Investment

You might be better off forming a corporation if you need to get outside investment from a bank, venture capitalist, or investor. Compared to sole proprietorships, corporations have an easier time collecting outside investment.

Companies can raise more money for expansion by selling stock, while lone proprietors can only get money from personal accounts, personal credit, or by hiring partners. Similar difficulties may arise for an LLC, even though it is not necessarily required for the owner to use their assets or credit as an individual.

Licenses, Permits And Regulations

To legally conduct your business, you might also need to register it and obtain the necessary licenses and permits. A business may require municipal, state, or federal licenses, depending on its operations and nature.

According to Friedman, "states have different requirements for different business structures." "There may also be different requirements at the municipal level, depending on where you set up." Recognize the state and sector you operate in when selecting your structure. There isn't a "one size fits all" solution, and firms might not know what applies to them.

The structures covered here are exclusive to for-profit companies. Friedman suggests talking with a business law expert if you've done your homework and you're still not sure which business structure is best for you.