One of the most important things you can do to be successful in running your own business is to choose the best possible business structure. That’s the official (legal) way that your business is organized. This is called “choice of entity” in a lot of tax and legal reference sources. I call it structure because I think that’s more descriptive and easier to understand.
Some of the choices for structuring your business are
- sole proprietorship
- partnership
- corporation
- LLC (limited liability company)
The business tax system is a little bit more complicated than the individual income tax system and the way that your business is structured determines which rules you’ll have to follow for figuring your taxes. The 1040 might seem complicated, but at least there’s just one set of rules and it applies to everyone.
Not so with business taxes. Sole proprietors have one set of rules, partnerships another, and corporations still another. Actually, corporations have at least two different sets of rules, depending on the type of corporation. And if the LLC has at least two members, it can choose from three different possibilities.
There are also some other areas that are affected by differences in business structure. The one you’re probably familiar with concerns liability. Some of the things included here have to do with who is responsible for business debts and who can be held responsible for the actions of the company.
Other effects of structure
Your business structure also determines
- how you handle payroll
- how you handle employee benefits
- how you handle retirement plans
- how you handle health insurance
- whether or not you can get any tax-free benefits from your company
Even if you think you won’t have any employees (or at least not for a while), you need to understand the differences so you’re not surprised later on and so you don’t get into trouble with the IRS. In certain cases, the IRS demands that you treat yourself as an employee for payroll purposes.
More effects of legal structure
Your legal structure also affects
- the way you’ll be able to raise money to put into the business
- how you’re allowed to get money out of the business
- how you can split up the profits (or losses) if there’s more than one owner of the business
The right structure for you depends on the type of business you want to start and your particular situation. The right structure for you might not be the same one that works for your best friend, neighbor, or sister-in-law who’s running the same kind of business as you are.
So take your time doing your research and learning about the details of the various business forms.
And remember that no matter what structure you choose to begin with, you’re not stuck with it forever. If you decide that you didn’t make the best choice when you first started or if your personal situation changes or your business grows, you can change the legal structure later on.
What happens if you don’t choose a structure?
If you’re a solo business owner and you don’t do anything to formally organize your business, you’ll be considered a sole proprietor. If you’re in business with others and you don’t set up any formal structure, you’ll be treated as a partnership.
Not only do the details of your personal life affect your choice of business structure, but the reverse is also true. Your choice of business structure can affect your personal situation.
As I said earlier, you can change your mind and your structure, but you’ll need to understand your options whenever you choose or change so that you make the best decision possible at that time.
It’ll be worth your effort.