Forming a Business

Forming a Business

Forming a Business

        Entrepreneurship is gaining popularity as a career option. More and more often, people are leaving the comforts of their 9 to 5 corporate jobs to start their own business venture. Many people believe that if they are going to put in a hard day’s work, they may as well do it for themselves. Of the many choices one makes when deciding to start their own business, one of the most important decisions is under which legal structure they will organize. Although many new entrepreneurs may be ignorant when making the decision about which structure they should form their business under, carefully differentiating between sole proprietorship, partnership, limited liability corporation (LLC), and a corporation will have an effect on your personal liability, the amount of paperwork required of your business, you tax situation, and your ability to raise capital.

Choosing an answer to the question, "What structure makes the most sense for my business?" is a decision that should not be made lightly. In answering the question, your individual circumstances, as well as the circumstances of the business and any other owner(s) or partner(s) must be taken into consideration. “Choosing a legal structure for your business is one of the first steps in transforming your idea into an actual, legitimate business” (Pakroo, 2014, p. 148). Four of the most common business structures formed are sole proprietorships, partnerships, LLC's, and corporations. Each of these structures encompasses uniqueness and has their own advantages and disadvantages.

Of all of the business organizations, a sole proprietorship is the most common. “A sole proprietorship is the simplest and most common structure chosen to start a business. It is an unincorporated business owned and run by one individual with no distinction between the business and you, the owner” (SBA.gov, 2015). It is easy to form, and the proprietor/owner has complete managerial control of the business. There are no forms that need to be filed to form it, and all profits earned are those of the owner.  However, you are also personally responsible for all of the liabilities, financial obligations, and taxes associated with the business.  A sole proprietorship is only taxed once, and the owner files all business income and expenses on his or her personal tax return. Of the four structures discussed in this essay, the sole proprietorship has the lowest tax rates. When the owner of a sole proprietorship dies, the proprietorship ends.

The next business structure covered is a partnership. Partnerships are comprised of two or more people that agree to carry out a for-profit business. Forming the partnership is fairly easy, typically inexpensive and has is straightforward. The partnership must register with the local Secretary of State’s office. “The best way to form a partnership is to draw up and sign a partnership agreement” (Steingold, 2015, p. 7), however, it can be drawn up without it being in writing. Having a partner(s) provides a means of combining resources, skills, and talents of the partners, as well as dividing the workload.

The partnership itself does not bear the tax liabilities of the businesses profits or losses. These taxes are “passed through” to the individual partners via their individual income tax return.  The partnership simply files an “annual information return” to account for the financial operations of the business. The biggest disadvantage of a partnership is the liability the partners face. “Liability is joint and several with those of the other partners, which means that partners may be sued together or separately for the full amount of the debt” (Rogers, 2012, chap. 13.1). The third structure to be discussed is the LLC.

“Despite its relative newness, the LLC is now the entity of choice for many because of its flexibility” (Hopson & Hopson, 2014, p. 43). A LLC takes the best of a corporation and partnership, and melds them into one, giving the owner(s) the limited liability of a corporation, and the tax benefits of a partnership. LLC’s are formed by paying a fee and filing Articles of Organization with the local Secretary of State’s office. Start-up costs are usually small. A LLC is not a separate tax entity. Like a partnership, its profits and/or losses are ‘passed through’ to its owner (s).

A good thing about a LLC is that the owners normally do not have to worry about their personal property when it comes to a business liability. Like a corporation, members of a LLC are shielded from personal liability for the decisions and actions of the business.  A downside to a LLC is its tax liability.  Although LLC’s are single taxed, in the eyes of the IRS, the members are self-employed and are responsible for paying their own self-employment taxes. Another disadvantage is that should a member decide to leave the LLC decide to leave, the LLC must dissolve.