Limited liability company or sole proprietorship? Partnership or corporation? Unfortunately, picking a business structure isn't a one-size-fits-all proposition. Let's look at how three different business structures impact the amount of business liability you personally take on and how you're taxed.
Sole Proprietorship: Personal Risks & Rewards
A sole proprietorship is the default status for any operation that has one owner, so you don't have to do much more than hang up your "Open for Business" sign to be one. Do you support yourself as a freelancer? You're sole proprietor. Own a pizza restaurant? As long as you're the only owner, your business is a sole proprietorship.
That structure comes with some serious perks. First, it doesn't take a lot of money or paperwork to be one. It's also a "pass-through" entity, meaning a sole proprietor doesn't pay corporate income tax.
But what about the drawbacks? The biggest is that you and your business are one and the same. You haven't created a separate legal entity, so you get all your business's liabilities, and that puts your personal assets at risk.
It might be hard to imagine someone suing your business, but as Nolo.com points out, lawsuits can come from:
And lawsuits are just one concern. According to the Small Business Administration, fundraising can be difficult, too. Many banks look at sole proprietorships skeptically, concerned that a failed business or bankrupted individual won't repay a loan. Without the ability to sell stocks, sole proprietors can find their hands tied when it comes to bringing in additional capital.
Limited Liability Company: A (Mostly) Sturdy Fence
If you want to spare your personal assets, you may want to look into a limited liability company. In this business structure, profit passes through to the owner as it does in a sole proprietorship. If your LLC is sued, your personal assets, such as your home or your savings, are generally safe because you usually aren't liable for the business's debts.
Notice I said usually. According to Nolo.com, you could take on the liability you want to avoid by:
- Causing a personal injury.
- Personally guaranteeing a loan that the LLC defaults on.
- Failing to deposit taxes withheld from your employees' pay.
- Intentionally committing a crime or acting recklessly.
- Inappropriately co-mingling your personal affairs with the LLC.
Any of these may result in your personal life, the harder it is for a lawyer to argue that your organization is an LLC in name only.
Corporation: Big Rewards, Big Costs
The appeal of a corporation? This structure makes your business a separate legal entity that has many of the rights people do. A corporation can...
- Enter into contracts.
- Loan money.
- Pay taxes.
Though a corporation can be sued, the owner's personal assets usually can't be collected. Another bonus: creditors can't come after you to settle your business's debts. Lastly, banks and venture capitalists are often more willing to do business with corporations because they seem more financially stable.
The downside: corporations pay taxes on their profits, as do shareholders when the profit is distributed as dividends. Even the IRS acknowledges this is tantamount to being taxed twice. Some businesses can get around that by applying to be an S corporation. If they meet the qualifications, which are listed on the IRS website, only the shareholders are taxed.
But the double tax isn't the only hitch. Both types of corporations are heavily regulated, making them expensive to establish and time-consuming to maintain.
The bottom line? This isn't a decision to make on your own. When it's time to choose a business structure, enlist the help of an attorney and tax professional. They can help you assess your risk and make the choice that suits your needs.