7 Essential Insights on Starting a Business

Choosing the right structure for your new business is a crucial decision that influences your daily operations, liability, personal taxes, and administrative responsibilities. Here’s a simplified overview of common business structures to help you decide.

A business structure, also called a business formation or legal structure, must be chosen before registering your business in your state. You’ll also need to get a tax ID number and apply for necessary licenses and permits. While you can switch structures later, it’s important to start with the right one to avoid potential restrictions and tax issues.

You don’t necessarily need a lawyer to form your business, but it can be helpful to consult one. A business attorney can recommend the best entity type for you and ensure you meet all formation requirements, including completing and filing complex paperwork like operating agreements and shareholder agreements.

A sole proprietorship is the simplest structure, giving you complete control over your business. If you conduct business activities without registering as another type, you’re automatically a sole proprietorship. However, this structure doesn’t separate your business and personal assets, exposing you to personal liability for business debts. While you can use a trade name and test your business idea as a sole proprietor, selling stock is not an option, and getting a bank loan might be challenging.

A limited liability company (LLC) combines the benefits of partnerships and keeps your personal assets protected if your business faces legal issues or bankruptcy. Profits and losses pass through to your personal income, avoiding corporate taxes, but you will need to pay self-employment taxes. This structure is suitable for medium- or high-risk businesses looking for asset protection and a lower tax rate compared to corporations.

Partnerships allow two or more people to share ownership. There are limited partnerships (LP) with one partner having unlimited liability and limited liability partnerships (LLP) where all partners have limited liability. Partner roles and liabilities are typically detailed in a partnership agreement.

Corporations, like C corporations (C corps), are separate legal entities from their owners, capable of making a profit, being taxed, and held legally liable. Although providing strong personal liability protection, forming a C corp is costly and involves substantial administrative work. Corporations pay income tax on profits, possibly leading to double taxation when dividends are distributed. However, a corporation’s continuity isn’t affected by shareholders selling their shares. C corps are effective for raising capital.

An S corporation (S corp) avoids the double-taxation issue by passing profits and some losses directly to owners’ personal incomes. Rules for S corps vary by state, and it’s important to check with the IRS on any specific requirements. Like C corps, S corps exist independently of their owners.

Benefit corporations (B Corps) operate like C corps but focus on mission-driven goals alongside profit. They often need to provide annual reports demonstrating their positive societal impact.

Lastly, keep in mind that some entities like an S corp also function as tax statuses rather than strict business structures. For instance, an LLC can be taxed as an S corp or a nonprofit, though these setups are more complex and usually require legal advice.