Biz Talk: Which Business Structure is Right for You?

One of the most critical decisions you have to make in starting a business is the selection of the appropriate legal structure for your company. Choosing the right one will help you manage your operations and business finances efficiently.  

Each structure has its own advantages and disadvantages, so you will have to determine for yourself which are your biggest concerns. Please take note also that laws governing business formation vary from state to state.

You should look carefully into more specific details about each form of ownership before choosing which one is right for you. Although there are variations to these basic structures, here’s a brief description of each of the more popular ones:

Sole proprietorship is the most common because it is the least expensive and the easiest to form and dissolve. It is owned and operated by one person who is solely responsible for all its profits and personally liable for all its debts or financial obligations.

The owner reports profit or loss on his or her personal income tax return because the business is not a separate entity, i.e., the business and the owner are one and the same. This type of business organization is referred to as: [owner's name] "doing business as" or dba [business name].

A general partnership is similar to a sole proprietorship except that it is owned by two or more persons who have agreed to do business together. Each partner contributes cash, equipment, property, labor or skill as capital and expects to share in the profits and losses of the business based on agreed-upon proportions or percentages.

Generally, the more owners a business has, the more funds it can raise. Partners are jointly and individually liable for the actions of the other partners.  

A corporation is a legal entity separate from its owners. It is more complex than other business structure.

A corporation exists on its own and does not dissolve when ownership changes. It can be taxed, sued and held legally responsible for its actions.

A corporation is formed under the laws of the state where it is organized and is subject to corporate income tax at the federal and state levels. In addition, any earnings distributed to its owners, also called shareholders, in the form of dividends are taxed at individual tax rates on each shareholder's personal tax return.  

A corporation requires more paperwork than the other business structures because it has more regulations and tax requirements. 

A limited liability company (LLC) is a relatively new hybrid business structure that is now recognized in most states. It has the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.

An LLC's formation, however, is more complex and formal than that of a general partnership. LLC owners are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign entities.

Most states also permit “single member” LLCs, those having only one owner.

After five of my friends expressed interest in becoming part of CoffeeShop Treats,* we decided to organize ourselves as a member-managed limited liability company. Every one of us saw the great potential of this business concept, so we opted for the LLC structure to be able to expand easily in terms of financing and ownership without the hassle of compliance with the reporting requirements of corporations.  

According to Angel Thomas of Patriot Tax Professional, “Most business start-ups are organized as sole proprietorship to make it simple until they get more customers and need to hire more employees. They usually operate as home-based businesses to maintain low overhead costs.

“Individuals wishing to form a start-up should determine the company's tax situation beforehand by projecting its annual income. This will help you understand and comply with federal and state tax requirements, and help you calculate cash to be saved for business operations.” 

If you are a business starter with very limited capital funds—and most are further burdened with today's tight credit approval requirements—think carefully about the right business structure for you. Choosing the right one will help you avoid potential legal and tax liabilities that could significantly affect your bottom line.

There is no perfect business structure. The type of business entity you choose will affect the amount of taxes you will pay, the volume of paperwork your business will be required to do, the personal liability you will face and your ability to borrow money.  

This article is for informational purpose only and should not be taken as a legal or accounting advice. For more details, consult your accountant or tax attorney.

*Our café-bakery, CoffeeShop Treats, LLC, was sold in 2007.