Deciding On Your Business Type
One of the very first steps you need to take is to give your new business an identity. This is necessary for tax purposes and will help you as you begin to plan for the future. You may or may not know what your options are when it comes to the different structures your business can take. The four possibilities are listed below. Learn as much as you can before making a decision. In addition, be sure to consult a lawyer to assist you and to answer any questions you may have.
In this situation, you own the business yourself and can reap whatever financial benefits come from it. You can make decisions on your own and guide the growth of the business without having to consult with any other entity. This also means that no other employee will ever have the chance to have a piece of the pie (i.e. own stocks).
This may sound pretty good. Just be aware that with a sole proprietorship, there is no boundary between your business life and your personal life as far as taxes and other financial obligations are concerned. As far as the government is concerned, you and your business are one and the same. This could have negative repercussions on you. Lastly, as a sole proprietor your business will exist only as long as you continue to own it.
Just as the name implies, this type of business involves two or more people who share ownership in the business. In the same way as a sole proprietorship, a partnership draws no financial distinction between your personal and business finances. There are also inherent risks in partnerships. It is important to draft a “partnership agreement” to outline what happens if there is a disagreement among partners, if one wants to end the partnership, if one of the partners dies, etc.
There are three different types of partnerships you can consider:
- General Partnership:
- This is the most basic type. It assumes equal partnership, and therefore equal ownership. All management and liability is shared between the partners, unless otherwise specified.
- Limited Partnership (a Partnership with Limited Liability):
- Here, the partners are responsible to the extent of their investment. This means that decision making is also based on the amount of money a partner has contributed to the enterprise. This becomes more formal and more complex.
- Joint Venture:
- This type of partnership is time-based. Two or more individuals may work together for a particular project or for an extension of time. Upon completion, the partnership is dissolved. If the individuals would like to continue to work together, they would then register as general partners.
Becoming “incorporated” brings with it many advantages. Your business becomes a separated entity (from you) and is chartered by the state in which it is located. This means that your business can enter into contracts, it pays taxes of its own, it can be sued. The owner becomes a shareholder and has the option to sell the business if things don’t work out for continued ownership. The negative piece of this option is that it is more expensive than the others and takes a bit more time.
Many new business owners will seek out the assistance of an attorney for incorporation (when you get to put “Inc.” after the name of your business). This is a possibility, but not the only option. Some lawyers may charge you a substantial amount of money (up to $1000 or $2000) for this process. A less expensive alternative is to contact a service such as the “Company Corporation” who can incorporate your business for significantly less money (between $150 and $350).
There are two types of corporations: the “C corporation” (described above) and the “S corporation”. What distinguishes the S Corp from the basic C Corp is the way the business is taxed. An S Corp allows its shareholders to treat profits as distributions and to pass them through to their personal tax return. The restriction is that the shareholder must pay herself a wage that is considered to be “reasonable.” In other words, pay that is equivalent to what someone would receive if they were paid as an employee. If this restriction is not satisfied, the IRS could re-classify all your profits as wages and force you to pay payroll taxes on all of it.
This is a rather new classification that is now allowed in most states. This distinction functions as a Limited Liability Corporation, but is taxed and operated in a way that is most consistent with a Partnership. Similar to a Joint Venture, a Limited Liability normally has a fixed amount of time upon filing. However, this timeline can be extended indefinitely if approved through a membership vote (in line with the structure of most Corporations). The sticky part is making sure that a Limited Liability business does not have more than two of the four qualities that characterize a corporation (limited liability concerning assets; continuity of life; centralization of management; the ability to transfer ownership interests). If more than two of these qualities are met, the Limited Liability becomes a Corporation and is taxed accordingly.