A Legal Structure for your Business

Entrepreneurs should take the time to weigh the advantages and disadvantages of choosing a particular legal structure for their business. Here are some options to consider.

A Straightforward Choice

A sole proprietorship is generally the easiest option for a business with only one owner. In general, the owner is
personally liable for all financial obligations and debts of the business. A sole proprietorship must be a business, not an investment or a hobby. However, the business may be conducted either part- or full-time. Sole proprietors do not have taxes withheld from their business income and generally need to make quarterly estimated tax payments if they expect to make a profit. Estimated payments include both income tax
and self-employment taxes (for Social Security and Medicare).

A Common Alternative

A limited liability company (LLC) can have one or more owners. It is a popular alternative because owners generally have limited personal liability for the debts and actions of the LLC. If the company is sued, the LLC structure can protect an owner’s personal assets. Depending on the elections made by the LLC and its members, the IRS will treat it as a corporation, a partnership, or as part of the LLC owner’s individual tax return.

A Complex Corporate Structure

A corporation is a legal entity separate from its owners and can be held legally liable for its actions. While shareholders are generally insulated from personal liability, they may be held responsible for the repayment of business debts they personally guaranteed. Corporations are subject to corporate income taxes at the federal and generally at the state level. Earnings that are distributed to individual shareholders in the form
of dividends are taxed on their personal tax returns.

An S corporation offers the limited liability of a standard corporation without the double taxation associated with dividend distributions from a standard corporation. An S corporation generally does not pay federal income taxes itself. Instead, the shareholders are taxed individually on their respective shares of the corporation’s taxable income.

Another Option

A partnership does not pay any income taxes at the partnership level, although it does file a return to report income and expenses. Partners report their individual shares of the partnership profit or loss on their personal tax returns. Like sole proprietors, partners must make estimated quarterly tax payments if they expect to make a profit.