If you find yourself running a business, you should really put a ring on it—that is, make it official by choosing the right legal structure. Your designation is only about 2% less of a major, long-term commitment than a marriage. So choose wisely.1. Learn about your options.
When it comes to legal structure, you have five basic options:
- Sole proprietorship: Not actually a formal legal entity, a sole proprietorship is a simple business form with one owner who is personally responsible for all debts associated with the business. Income and losses are reported on the individual’s personal income tax return.
- Partnership: A legal term referring to a business operation in which two or more individuals share management responsibilities, profits, and debts. There are a number of different types of partnerships you may hear about, but the most common are general and limited.
- Limited liability company (LLC): Business owners operate like a traditional partnership in that they share management responsibilities and profits, but their personal assets are protected from liability for business debts.
- Corporation: The corporation is a separate entity from the founders or owners and generally has most of the legal rights enjoyed by an individual. Upon formation, a corporation must distribute common stock and elect a board of directors.
- S-corporation: Similar to a corporation, an S-corp offers some tax benefits advantageous to smaller businesses and also protects owners from liability.
2. Consider the tax implications.
Sole proprietorships, partnerships, LLCs, and S-corps are all considered flow-through entities for tax purposes. That simply means that the company’s income is reported on the owner’s individual tax return, or shareholders’ returns in the case of an S-corp. Corporations are separate taxable entities that pay taxes based on their net income each year.
3. Choose the best structure for your long-term plans.
As you mull over the options, come back to your business plan:
- What are your revenue targets? How do they relate to the costs associated with each type of legal structure?
- How many owners will be involved?
- How many employees do you anticipate needing to hire?
- What tax structure makes the most sense?
- What is the appropriate level of risk? Remember that sole proprietorships and general partnerships leave you personally liable for business debts and obligations.
- Will you need investment capital? If so, you'll need a corporate structure so you can sell shares.
At this point, it can be extremely helpful to talk through the options with your CPA and/or business attorney.
4. Complete the paperwork.
Once you've decided on the right legal structure, you'll want to start by applying for a Federal Employer Identification Number (FEIN). You can either work with an attorney to file your paperwork or use a service like LegalZoom. You'll also need to choose a state in which your business will be based.
Signed, sealed, delivered: your business is officially legal! Do you know all the other things you should do at the same time? We put together a Business Start-up Checklist to help you make sure you’ve got all your bases covered.