How to structure a small business

2009 Small Business Guide

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small business

By Dan Weil • Bankrate.com

Table of contents

Chapter 1: Funding your startup

Chapter 2: Setting up the business

Chapter 3: Management strategies

Chapter 4: Tools for survival

Limited Liability Company, or LLC

As the name implies, your liability is limited under this structure. You can also avoid the double taxation that comes with a C corporation. Under that structure, the corporation pays its own income tax, and then shareholders are taxed when they receive dividends.

With an LLC, you can choose to have income passed through to the company's members. The company pays no income tax, but the members are subject to self-employment taxes. An LLC can have any number of members -- from one upward.

And unlike an S corporation, which has to distribute dividends in proportion to number of shares held, LLCs can divvy out profits however they choose. "You have a lot more flexibility using an LLC than other structures," says Saul Brenner, a partner at New York City accounting firm Berdon LLP.

Limited Liability Company, or LLC

Potential users: Any business that doesn't need to go public or attract venture capital quickly.
Advantages: Flexibility in ownership and dividend payment structures, limited legal liability, no double taxation.
Disadvantages: Self-employment tax, no tax deduction for dividends, uncertain legal environment compared to a corporation.

"You have the advantage of limited liability that you get through corporations, but a lot more flexibility as to allocation of income. You can get different people involved as equity owners with different classes of membership. It's far superior."

S corporation

S corporations aren't subject to double taxation and offer limited liability. Employees aren't subject to self-employment taxes.

S corporation

Potential users: Businesses that want the legal certainty of a corporate structure, but the tax treatment of an LLC.
Advantages: Limited liability, no double taxation, no self-employment tax.
Disadvantages: Inflexible ownership structure -- profits and losses must be allocated in proportion to ownership shares, you can't have corporate or foreign owners.

But be careful about pushing out all your income as dividends to avoid having to pay Social Security taxes. "If the IRS sees you didn't take out any of your income to pay salaries and didn't pay Social Security taxes, it can make you reclassify some of your income as salaries.

And keep in mind that an S corporation is limited to 100 shareholders and one class of stock. If you have a business for which you need a lot of investors -- a real estate development company for example -- that could be a serious disadvantage.