When you start a new business, it’s important to understand how the legal setup affects the way your business operates. The business structure determines whether your personal finances are tied to the business, how much tax your business will owe, how easy it is to raise money and even the amount of paperwork required.
Sole proprietorships are the easiest to begin. As the owner, you have complete control and you receive all the profits. You’re also responsible for all the work and for all the debt; your personal property could be sold to cover business debt. Financing can be difficult because banks may not want to loan money to a business with few assets. Yet as a sole proprietor, you’re free to operate the business the way you want.
In a partnership, at least one other person is in business with you. Each partner helps make decisions and shares responsibility. More input can help a business grow faster, but it can also mean giving up some of your ideas for your partner. Partners are personally liable for business finances, but unlike a sole proprietorship, the liability is shared; you’re not the only one responsible.
A corporation is legally separate from its owners and operators. The company makes profits, pays business taxes and is liable for financial debts. This saves you from personal financial risk, which is a main advantage. Instead, you file separate, personal income taxes on the salary and bonuses you receive from the corporation. Starting a corporation can be expensive, and there is a lot of recordkeeping involved. However, banks and investors may be more likely to help a corporation because it seems more secure.
Paying both business and personal taxes may seem like double taxation. Forming an S-Corporation, or subchapter corporation, can help by allowing you to pass through corporate income and losses to your personal taxes, just as you would in a partnership.
Limited Liability Corporation (LLC)
A limited liability corporation protects your personal assets from business debts while allowing you to use a partnership tax system. Because of this pass-through arrangement, LLCs don’t provide personal separation from business taxes. The initial setup is more complicated than in a partnership, but it’s easier to run an LLC than a full corporation.
Which is Right for You?
Looking at the amount of money you have to invest and at the possible risks to your personal finances can help you choose the right business structure. Understanding the options and even getting some professional advice can save you a lot of time and trouble from the start. Once you decide, you can then focus on building your successful business.
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