Tips for Choosing the Best Structure for Your Business
When you start your own business, choosing the right structure and learning how to incorporate a business is one of the most important things you can do. The type of structure you choose will be based on how many owners you have, the type of business you operate, the financial situation of your business and much more. While a complex decision, choosing to incorporate and selecting the right entity can bring with it many advantages, including limited liability and reduced tax costs.
To help you understand the importance of this decision, and choose the best structure for your business, here are some tips to keep in mind.
Consider Risks and Liabilities
Do you operate a high-risk business, such as stock trading or repairing homes? If so, the best option will be a business entity that offers personal liability protection, or limited liability, to protect your personal assets from the debts or claims of your business. In this case, it's a good idea to form an LLC or corporation, both of which offer the protection you need. With a sole proprietorship, general partnership or limited partnership, owners or partners will still be left personally responsible for business debt.
Consider Expense and Formalities
Another big consideration when you learn how to incorporate a business is the expense, as well as the formalities that go along with each business structure. Sole proprietorships and partnerships are by far the easiest businesses to set up, requiring no filing or fees with no special operating rules to worry about.
With an LLC or corporation, there will be fees to pay to incorporate, which depends on the state. You must also elect officers for your company, keep records and file documents with the state regularly. Still, it's a good idea to understand the differences of an LLC vs corporation, as LLCs are by far the more affordable of the two to form and they have much more lenient rules to follow.
Understand Tax Consequences
If you choose to form an LLC, partnership or sole proprietorship, all business profits will be taxed the same way. All of these business structures are what are known as pass-through entities, meaning profits and losses of the business are passed through the business to the individual owners, who report their share on their individual income tax return.
If you form a corporation, your share of corporate profits is not reported on your individual return and you will instead pay taxes on the profits you receive as a salary, bonus or dividends. Still, the corporation itself pays taxes at the corporate tax rate, as well as taxes on dividends paid out to shareholders. This is known as double taxation, as income is taxed first at the corporate level and again once it's distributed.
It's important to note, though, that you have the option to decide how you want to be taxed if you form an LLC, which can be a major advantage. You can choose to be taxed as a C corporation, an S corporation or a pass-through entity.
Consider Future Investment Needs
If you plan to turn to investors in the future, it makes sense to form a corporation, as this structure allows you to share ownership shares to attract investment capital. Many investors will only invest in corporations, not LLCs. If you don't need to worry about investors, you don't want to issue stock options and you're sure that you won't ever take the company public, it's probably not worth the increased cost and time spent to form a corporation. Instead, choose to form an LLC to gain the same protection with greater flexibility and lower cost.
While learning when and how to incorporate a business is a major step, keep in mind you can choose to convert your business to another structure later on if your risk grows, you decide to take on investors or your business becomes larger.
To help you understand the importance of this decision, and choose the best structure for your business, here are some tips to keep in mind.
Consider Risks and Liabilities
Do you operate a high-risk business, such as stock trading or repairing homes? If so, the best option will be a business entity that offers personal liability protection, or limited liability, to protect your personal assets from the debts or claims of your business. In this case, it's a good idea to form an LLC or corporation, both of which offer the protection you need. With a sole proprietorship, general partnership or limited partnership, owners or partners will still be left personally responsible for business debt.
Consider Expense and Formalities
Another big consideration when you learn how to incorporate a business is the expense, as well as the formalities that go along with each business structure. Sole proprietorships and partnerships are by far the easiest businesses to set up, requiring no filing or fees with no special operating rules to worry about.
With an LLC or corporation, there will be fees to pay to incorporate, which depends on the state. You must also elect officers for your company, keep records and file documents with the state regularly. Still, it's a good idea to understand the differences of an LLC vs corporation, as LLCs are by far the more affordable of the two to form and they have much more lenient rules to follow.
Understand Tax Consequences
If you choose to form an LLC, partnership or sole proprietorship, all business profits will be taxed the same way. All of these business structures are what are known as pass-through entities, meaning profits and losses of the business are passed through the business to the individual owners, who report their share on their individual income tax return.
If you form a corporation, your share of corporate profits is not reported on your individual return and you will instead pay taxes on the profits you receive as a salary, bonus or dividends. Still, the corporation itself pays taxes at the corporate tax rate, as well as taxes on dividends paid out to shareholders. This is known as double taxation, as income is taxed first at the corporate level and again once it's distributed.
It's important to note, though, that you have the option to decide how you want to be taxed if you form an LLC, which can be a major advantage. You can choose to be taxed as a C corporation, an S corporation or a pass-through entity.
Consider Future Investment Needs
If you plan to turn to investors in the future, it makes sense to form a corporation, as this structure allows you to share ownership shares to attract investment capital. Many investors will only invest in corporations, not LLCs. If you don't need to worry about investors, you don't want to issue stock options and you're sure that you won't ever take the company public, it's probably not worth the increased cost and time spent to form a corporation. Instead, choose to form an LLC to gain the same protection with greater flexibility and lower cost.
While learning when and how to incorporate a business is a major step, keep in mind you can choose to convert your business to another structure later on if your risk grows, you decide to take on investors or your business becomes larger.
