Choosing the Legal Structure of Your Business

Published: Mar 31, 2009

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The legal structure of your company is extremely important. The legal form of your business will have an effect on the amount you pay in taxes, your company and personal liability, investment capital and many other areas. Choosing the legal structure that best matches your company profile will help to ensure that your company experiences optimum protection and stability.The basic options for the organization of your business are:

1.Sole proprietorshipSole proprietorship is the simplest organizational structure to form. If you do not incorporate and do not have a partner, you are automatically a sole proprietorship. Operating a sole proprietorship means that the profit of your business is taxed as personal income, and you are personally liable for any debts or losses.

2.Incorporation Incorporating provides your business with protection from liability. By incorporating, you are establishing your business as a legal entity separate from yourself. This means you and your personal assets are not liable if something goes wrong with the business.

3.S corporationAn S corporation provides you with the liability protection of a corporation and also enables you to pay taxes like a sole proprietor or partnership. Many experts recommend this for startups because it provides protection and reduces your tax burden.

4.C corporationA C corporation allows your business to file and pay taxes on the income amount derived after all business expenses are deducted. It can be beneficial to establish a C corporation if you plan to keep large amounts of profits or other cash in the bank to make future capital expenditures. Unfortunately, entrepreneurs who set up C corporations are subject to potential double taxation - once as a corporation and a second time on a personal level when they cash in on the profits or sell the company.

5.Limited partnershipA limited partnership is generally used for real estate investments or when a business is planning financial expansion. The advantage of limited partnerships is they allow small businesses to raise capital without bringing in new partners, forming a corporation or issuing stock. Limited partners are not personally liable for the debts of the company and have the same tax rights as general partners, but usually cannot hold management positions.

6.PartnershipThe benefit to forming a partnership is the ability to share the financial burden with another person or group of persons. Make sure to put the partnership agreement in writing. The risk of a partnership is that you are personally liable for the actions of the other partner(s).

7.Limited liability corporationThe limited liability corporation is a cross between a corporation and a partnership. It provides the beneficial tax breaks of a partnership while also offering the protection of a corporation. The LLC is very similar to the S Corporation and limited partnership but is more flexible.

8. Special cases

  • Non-ProfitThe main benefit of being a non-profit is that you are exempt from paying income taxes. You must qualify under the IRS Section 501 (c)(3) rules. Typically, this designation is for organizations that are educational, scientific or religious in nature.
  • Professional CorporationsProfessional corporations must be formed for the sole purpose of offering a professional service. They are usually formed to shield the owners from certain liabilities. The descriptions listed above are very basic and do not include all of the intricacies of the different structures. They are meant to give you a basic idea of the different options available. Make sure to consult a legal professional and find out all of the benefits to the different organizational structures.

Things to think about

  • Which aspects of incorporation are of the most benefit to your business?
  • Which type of incorporation makes the most sense for your business?
  • Do you have one or more potential partners, or will you bear sole responsibility?
  • What tax and liability issues will affect your business?
  • What structure best mitigates these issues?