Legal Basics

TYPES OF LEGAL STRUCTURE FOR YOUR BUSINESS

SOLE PROPRIETORSHIP

It is the simplest legal structure, which is popular among solo business owners. Your expenses and income from the business are included on your personal income tax return.

  • PROS: Any business losses you suffer may offset the income you have earned from your other sources. It is also a low cost and easy option, especially if you are looking to test your business concept.
  • CONS: You are on the hook for all your company’s liabilities. That means if your business seeks bankruptcy protection or you get sued, your personal assets may be at risk, and could be seized.
  • BEST FOR: Business owners with no or few employees, such as consultants, who can handle legal risks with adequate insurance or do not have assets to protect.

PARTNERSHIP

There are two types: general and limited. In a general partnership, a credit may go after any or all of the partners. A limited partnership is compromised of a general partner with unlimited personal liability and limited partners whose liability is generally limited to the amount they have invested in the company. You have to report profits and looses in an informational tax return, and file with your personal tax return.

  • PROS: It is another relatively low cost and easy way to form a business. Plus, there usually can be some tax advantages to reporting your share of the profits and looses on your personal tax report.
  • CONS: General partners can be personally at risk, even if another partner is the one who sinks the company.
  • BEST FOR: Business that will be owned and operated by several individuals. It is a common structure in the real state industry.

CORPORATION

A corporation is an independent legal entity, separate from its owners, which means greater protection from personal liability in case the company is sued or files for bankruptcy. The S-Corporation is most common; C-Corporation is mainly used to set up high-profile ventures. Along with shareholders, corporations are held accountable to a board of Directors.

  • PROS: Since the corporation’s debt is not considered that of its owners, you will not necessarily have to risk your personal assets (beyond your investment in the corporation).
  • CONS: It is more expensive and complex, requiring more accounting and tax-prep help to ensure you are following all the rules. An S Corp has a limit of 100 shareholders.
  • BEST FOR: Business that need liability protection and flexibility to grow into a large organization. It is a common structure for manufacturers and restaurants.

LIMITED LIABILITY COMPANY (LLC)

LLSs were created to provide the liability protections that corporations enjoy without the double taxation. Earnings and losses pass through to the owners and are included in their personal tax returns.

  • PROS: LLCs offer liability protection without some of the formalities of a corporation, and tend to be less expensive to set up. This structure offers even more attractions than a S corp since there is no limit on the number of shareholders in a LLC.
  • CONS: Depending how the entity elects to be taxed, you may have to pay self-employment tax on your share of the draw.
  • BEST FOR: This adaptable structure is popular among businesses that are just starting out and not totally sure how much they will grow in the first year or so.