Business planning: Choosing a legal structure
out of the gate, you'll have to determine what structure your company
will take for tax and legal purposes. The common forms are a corporation,
a sole proprietorship or a partnership. Laws vary significantly
from state to state so be sure to contact the state office that
handles business services -- usually the office of the secretary
of state -- before filing for these structures.
How you decide to form your business will depend in
large part on:
- The type of business you have
- Tax advantages
- Potential liabilities
- Your level of income or earnings
The IRS gives entrepreneurs the choice of five types
of business entities:
This low-maintenance business structure puts up few legal hurdles
and costs almost nothing to establish. More than 75 percent of all
businesses are sole proprietorships, according to the Service
Corps of Retired Executives. But the structure offers no protection
from liability, and that makes it difficult to raise money.
As a sole proprietor you have absolute authority over
the business and you own all the assets. If the company makes a
profit, it's yours. Of course, if the company incurs a debt, so
do you. One way to create balance in the work and debt load is to
form a partnership.
Proprietorships usually have to pay local licensing
fees and may need to file a business name statement.
Commonly used by doctors and lawyers, partnerships offer no liability
protection. In fact, each partner not only has to guarantee liabilities
but is also responsible for any partner's negligence. Profits and
losses are divided among partners.
There are two kinds of partnerships, general and limited.
In a general partnership, the partners share equally, for better
or worse. A limited partnership consists of at least one general
partner and one limited partner. The general partner has greater
control in some areas of the business. The limited partner is limited
by the amount of his investment.
Partnerships may need to pay for attorney services
to draw up agreements, and usually file with the state for recognition
as a business entity.
The corporate structure offers the owners, called shareholders,
a way to separate themselves legally from the business. The shareholders
own the corporation and the corporation owns the business assets,
so personal liability is limited.
For the owner of a small, part-time business, incorporation
is probably more trouble than it's worth. But if the business has
any employees and the company makes more than $8,000 a year, forming
a corporation would provide a benefit due to tax structuring.
Here's why. Sole proprietors pay a 15.3 percent self-employment
tax on income. An S Corporation -- a common corporate entity for
small business -- doles out money in two forms: wages and profit
distributions. Profit distributions are exempt from the 15.3 percent
self-employment tax. So an S Corporation saves $1,530 for every
$10,000 profit distribution. If the S Corporation brought in $8,000,
the entrepreneur might pay himself $6,000 in wages and call the
other $2,000 a profit distribution. Therefore, the entrepreneur
wouldn't have to pay the Internal
Revenue Service 15.3 percent of that $2,000, or $306, which
is about equal to the cost of incorporating.
Corporations usually pay attorneys to draw up incorporation
papers, which are then filed with the state. They are required to
appoint an agent who lives in the state to accept any documents
being served on the corporation. There are two basic types of corporations,
the S Corporation and the C Corporation.
- S Corporations -- The Service Corps of Retired
Executives says this structure is most appropriate for startups.
It limits liability while sheltering some of the self-employment
taxes paid by sole proprietors. The S Corporation limits the number
of shareholders in the company to 75, and allows for only one
class of stock.
- C Corporations -- So known because they are taxed
under regular corporate income tax rules, C Corporations also
offer liability protection. But unlike other business structures,
the C Corporation's income is taxed twice. The corporate income
is taxed, and the dividends paid to stockholders are subject to
personal income tax.
And then there is the Limited Liability Company. The
LLC is a hybrid structure. It combines the tax advantages of a partnership
and the liability protection of a corporation. Owners are called
members and the company can issue both voting and non-voting stock.