Open for Business: Choosing the Right Structure for Your Company

You've done your research, written your business plan, quit your job and hung the shingle outside your front door. You are open for business. But what kind of business are you? A sole proprietor, a limited liability corporation? How you structure your company will affect how the company files taxes and what your personal liability will be.

Learn more about the options available to you and how to get it done.

Sole Proprietor

If you are self-employed and have not otherwise incorporated you are, by default, a sole proprietor. This is the only business structure that does not require any legal filing. And although some independently owned companies remain sole proprietorships for the life of the business, this structure can be risky. If you are a sole proprietor, in the government's eyes you and your company are one in the same. That means that you are personally liable for company debt. All of your personal assets are at risk if your company is sued, and are fair game for creditors.

Partnership

A partnership is very similar to a sole proprietor except that there are multiple company owners. A legal agreement should be drawn up that outlines each partner's contribution, how decision will be made and how profits will be shared. Like a sole proprietor, partners are legally liable for the company debt. The company is not taxed, but partners must declare any profit on their personal tax returns.

Corporations

The most formal of business structures, incorporating takes time and money. Corporations are monitored on a federal and state level resulting in more paperwork throughout the year. However, incorporating does insulate the business owners from financial liability. Generally, shareholders (the term for owners of incorporated businesses) can only be held liable for up to the amount they have invested in company stock. One drawback of incorporating is double taxation. The company is taxed on profits, and the shareholders are taxed again when they receive their share of these profits.

Corporations are also required to follow certain operating mandates such as holding and recording annual meetings, issuing stock certificates and electing a board of directors.

Subchapter S Corporation

The double taxation of a corporation can be avoided with a Subchapter S election. This tax election allows profits from the company to be taxed only as income to the shareholders who receive it. Subchapter S corporations have the liability protection of a corporation and are taxed like a sole proprietor or partnership. The only caveat is that shareholders must pay themselves a "reasonable compensation." To the IRS, this is the amount of money a company would have to pay someone else to do the job. If this is not done, the IRS can reclassify all company earnings as profit and charge payroll taxes on the entire sum.

Limited Liability Corporation (LLC)

Some small businesses find the flexibility of a Limited Liability Corporation advantageous. An LLC can decide whether to pass company profits directly to its members, and not pay company taxes, or it can elect to be taxed like a corporation. An LLC is a less formal structure than a corporation. There is no stock issued, and the company is not required to adhere to official procedures like annual meetings or the recording of minutes.

Which is Right for You?

Your accountant or tax advisor is a good place to start when deciding on a business structure. There are also on-line resources like www.incorporate.com that will walk you through a series of questions designed to help you make this decision.

Getting It Done

Once you have decided which business structure is best suited for your company, you can incorporate online in a matter of minutes. Sites such as My Corporation (owned by Intuit), or LegalZoom will file the necessary documents and send you a binder complete with company minute templates, blank stock certificates, sample bi-laws and even a corporate seal.