If you’re about to launch a business, or your business situation has recently changed, you may be questioning what sort of organization structure to choose. You can elect to classify your business in a number of different ways, depending on how you’d like the IRS to treat you. Here’s a look at your options.
1) Sole proprietorship – If you’re working on your own, you’re a sole proprietor by default. There’s no need for messy legal contracts for this classification, and your business gains and losses can be listed on your personal income tax return. But even though it’s easy to set up a business this way, there are pitfalls: Namely, you’re fully liable for business debts and lawsuits, which can put your personal property at risk. If you want to protect your assets, consider another structure.
2) General partnership – When you’re working with one or more co-owners, you may elect to form a partnership. You’ll file a tax return for the business, and will also report your share of loss or profit on your personal return. As with a sole proprietorship, you and your partners are personally responsible for business debts.
3) Limited partnership – In a limited partnership, you must have at least one general partner who bears the burden of unlimited personal liability. A limited partner will only be liable for the amount of his investment in the company. If you own a business, you might consider giving a potential smaller investor limited partner status.
4) Corporation – This is generally only a good option if your business has many shareholders and substantial revenues, as it may require significant legal fees to set up this structure. Corporations are subject to formal rules, such as keeping minutes for shareholder meetings. None of the shareholders are personally liable for the business’ debts, but filing taxes can be tricky: Shareholders for C corporations are taxed on the company’s dividends, even though the business already paid taxes on these earnings. (You can form an S corporation to get around this double-taxation issue, but you must meet certain criteria.) On the bright side, corporations are able to make full deductions on health insurance premiums, which is not the case for partnerships or sole proprietorships.
5) Limited liability company (LLC) – This structure offers the best of both worlds for many business owners. LLC owners cannot be held liable for the company’s debts, so the structure protects their personal assets in case of bankruptcy or a lawsuit. However, LLCs are not subject to nearly as many strict regulations as corporations are, and owners have flexibility in how they choose to share profits. LLC members are able to file their taxes classified as a sole proprietorship, partnership, or corporation depending on certain circumstances; ask your accountant which option is the best fit.
Deciding how to classify your business is a complex issue that can have long-standing implications. Talk with a lawyer or an accountant to find out which structure best suits your business.
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