Deciding how to structure a small business is a vital step for an entrepreneur. Business structure can determine factors like eligibility for business financing, building business credit, liability protection, credibility and taxes. Ultimately, the choice boils down to your specific needs and goals.
How to structure a small business
The advice of an attorney may be necessary when determining how to set up a business but here are the most common business structures:
This is the simplest and most common form of small business. In a sole proprietorship, the business is owned and operated by one person, who is personally responsible for all aspects of the business.
A sole proprietor has total control and receives all profits from the business and is responsible for taxes and liabilities.
If a sole proprietorship is formed with a name other than the individual’s name, a Fictitious Business Name Statement may be required by the local city or county where the principal place of business is located.
A partnership is a business structure in which two or more people share ownership of the business.
Partnerships can be general partnerships, in which all partners share equally in the profits and losses, or limited partnerships, in which some partners have limited liability and are not involved in the day-to-day management of the business.
The C-Corporation acts as a separate legal entity which is distinct from shareholders. There is no limit to the number of shareholders and shares can be held by non residents and citizens who do not reside in the United States. The corporation must pay federal and state income taxes on earnings. The earnings are distributed to shareholders and the shareholders are also taxed. Double taxation occurs. The benefits of the C-Corporation:
- Limited liability for the directors, officers, shareholder and employees of the corporation.
- C-Corporations can attract potential investors through the sale of shares of stocks.
- More than one type of stock can be issued.
- The C-Corporation exists whether or not the owners leave the business.
- Standard business expenses can be deducted as well as benefits to employees.
- Fringe benefits may be deducted such as group term life insurance, health and disability insurance, death benefits and employee medical expenses not paid by insurance as a business expense.
- Shareholders who are also employees are exempt from paying taxes on fringe benefits.
- Profit and loss can be split between the owners and the business to lower the overall tax rate.
- Corporate losses can be carried over to future tax years.
The S-Corporation is generally exempt from corporate income taxes on its profits. The shareholders pay income taxes on their proportionate share of the profits. Shareholders report the income and pay taxes, if any. One of the issues associated with the (C) corporation is that the corporation along with its owners are taxable. This is where the term “double taxation” comes into play because the corporate income is often taxed twice. The benefits of the S-Corporation:
- Limited liability like C-Corporations. S-Corporations are also considered to be to be separate entities apart from their owners.
- Debts incurred by the corporation are the responsibility of the corporation, not its shareholders, who can only be held accountable up to the amount they invested in the corporation.
- No double taxation as in the C-Corporations. According to the Internal Revenue Service, an S corporation is not a separate taxable entity, the corporation’s profits are considered to be the shareholders’ .
- Losses appear on the shareholders’ personal income tax returns just as profits do so at the end of the year if the corporation experiences losses shareholders end up owing less or even no taxes after they deduct their share of the corporation’s losses.
Limited Liability Company
A limited liability company (LLC) is a business structure that combines the limited liability of a corporation with the pass-through taxation of a partnership or sole proprietorship. This means that LLC owners are not personally liable for the debts or liabilities of the LLC, and the profits and losses of the LLC pass through to the owners and are reported on their personal tax returns.
LLCs are a popular business structure for small businesses because they offer many advantages, including:
- Limited liability protection – LLC owners are not personally liable for the debts or liabilities of the LLC. This means that if the LLC is sued or goes bankrupt, the owners’ personal assets are protected..
- Easy to form and maintain – LLCs are relatively easy to form and maintain. The requirements for forming and maintaining an LLC vary from state to state, but they are generally less complex than the requirements for forming and maintaining a corporation and there’s no requirement of an annual general meeting for shareholders.
- Limited paperwork and record keeping as compared to the C-Corporation and S-Corporations.
- Pass-through taxation – LLCs are pass-through entities, which means that the profits and losses of the LLC pass through to the owners and are reported on their personal tax returns. This can be beneficial for LLCs with a low net income, as it can avoid double taxation..
- Flexibility – LLCs are relatively flexible business structures. LLC owners can choose to manage the LLC themselves or hire a manager. They can also choose to be taxed as a sole proprietorship, partnership, or corporation..
- In most States, not all, LLCs are treated as separate entities from their members.
LLCs are a good choice for a variety of businesses, including small businesses, startups, and professional service businesses.
A cooperative is a business owned and controlled by its members, who share in the profits and decision-making.
Purchase a Shelf or Aged Corporations
A shelf corporation or aged corporation is a company that has been formed and registered with the state but has not conducted any business activity.
The term “shelf corporation” comes from the idea that these companies are “sitting on a shelf,” waiting to be purchased by someone who wants to start a business with an established corporate structure.
Shelf corporations are usually sold to entrepreneurs or investors who want to start a new business quickly without going through the time-consuming process of forming a new company. By purchasing a shelf corporation, the new owner can immediately begin doing business under an established corporate name and with a pre-existing legal and financial history.
Potential advantages and risks of shelf corporation:
- One potential advantage of purchasing a shelf corporation is that it may be viewed as a more established and credible business entity than a brand new startup.
- Potential risks associated with purchasing a shelf corporation, include assuming any liabilities or legal issues that may exist from previous business activities or transactions.
It’s important to conduct thorough due diligence and consult with a legal and financial professional before purchasing a shelf corporation to ensure that it is a viable and appropriate option for your business needs.
More Small Business Resources
- Check out how to establish business credit without a personal guarantee.
- Check out business loan options for bad credit.
- Discover the best online business checking accounts that can be opened from the comfort of your home or office.
- Find out why microloans are a good option for small business owners with bad credit.
- Get quick funding with a merchant cash advance.
- Find business checking accounts that don’t use ChexSystems for entrepreneurs with ChexSystems records.