03 May Know Your Business In and Out: Identifying the Right Business Structure
Much like any big decision in life – buying a house, finding a major in college, or choosing a wedding dress – there are so many things to consider when choosing the right type of business structure. All angles have to be looked into and assessed. Each business is different. Much like a person, one business possesses a different personality than the other. This is why a particular business entity is appropriate for one but not the other. There is no such thing as the best business structure in general sense. But there is a business structure that is best suited for your particular business.
Let’s now look at the type of business structures.
It is the most common form of business structure. It is also the easiest to accomplish, hence, its popularity. A sole proprietorship also allows the owner to have complete managerial control over the business. The sole proprietor owns the company, controls the business and is solely responsible for its assets and liabilities. The owner’s finances and properties are directly tied to the business.
A partnership involves two or more people who have agreed to share in the responsibilities of the business. It means that they will share in the profits and losses. Much like a sole proprietorship, it is directly tied to the business in the sense that the company is not treated as a separate entity when it comes to tax payments. So each partner will pay tax based on the individual tax return. The disadvantage therein is when a liability is incurred because each partner is going to be financially or legally liable to the company.
It is more appropriate for businesses that have a large number of employees. A corporation is a separate entity that is authorized to do business on behalf of the people that own the company. Because there is already a corporation that represents the business, the owners are not directly tied to it. It means that the corporation taxes the business and all liabilities will be addressed to the corporation.
Two types of a corporation:
It is the standard corporation, which takes the above description.
It essentially means a sub-corporation, which means that the tax responsibility is passed through the individual owners as if the business is a sole proprietorship or a partnership. The tax for the business, therefore, is reported as part of the individual tax return.
Limited Liability Company (LLC)
It is primarily a hybrid between the sole proprietorship/partnership and the corporation. Basically, regarding tax, it goes to the owner or owners. Profits and losses are passed through the owners. However, the owners are not at risks when it comes to liabilities as these will go to the company. More and more entrepreneurs are turning to LLC because of its advantages.
It is not usually considered a business structure because a cooperative is that first – a cooperative – before it is a business entity. A cooperative is creative because of a shared goal among a group of individuals. Business comes after the cooperative is formed because every coop wants to earn money for its members. A business, on the other hand, is created with the goal of earning at the onset.
Now that we have established the kinds of business structures, how do you choose the right type of the business you intend to open?
Here are some of the factors that you need to consider.
We have mentioned the word “liability” in this piece a lot of times. That’s because it is an important consideration when one is trying to identify the best business. Can you afford the risk of financial and legal liability? If the answer is in the affirmative, then a sole proprietorship or a partnership will be an appropriate structure for the business. This is why most startups prefer to open a sole proprietorship, if there is only one owner; or, a partnership for multiple owners.
Here is the scenario. When the business incurs a liability that is greater than the business profit and assets, then the balance will be offset by your money and property. As a sole proprietorship or partnership, every liability is charged to the owner or partners. If you or your partners think that you can take that risk, then the mentioned business structures are good enough. Especially since these are the easiest to form.
However, if you feel the need to protect your assets, then you have to make your company become a separate entity through a corporation or an LLC.
How complicated is your business?
The more complicated it is, the more complex the structure is needed. Remember that we tackled how sole proprietorship and partnership are the easiest to accomplish. So if your business involves easy tasks like creating jams in your kitchen, making items from your basement, providing online services through your computer or making artwork in your backyard, then a sole proprietorship is just what you need.
If you and your mates intend on providing cleaning services or are designing T-shirts, then a partnership will suffice.
But if you are already involved in the large-scale manufacturing of T-shirts with a factory and dozens of employees, then maybe it’s about time to form a corporation.
With the type of business that you own, how do you minimize tax?
The problem with corporations is usually associated with the double taxation. It is because the company, as a separate business entity, will be taxed by the IRS. And you, as a business owner, will still have to pay individual tax to Uncle Sam. But of course, if your business already employs a significant number of employees, then this is just the best option. However, if you want to evade the double-tax problem, then you may register as an S-Corporation.
According to Entrepreneur magazine, an S-corporation is available to companies with less than 70 shareholder returns. Business losses can help reduce personal tax liability, particularly in the early years of a company’s existence.