For legal and financial purposes, you must have a formal structure for your business. Your four basic choices:
1. Sole proprietorship. The owner and the business are the same
(usually a service business, with the owner
providing the service). Business and personal tax returns are filed
According to the U.S. Small Business
Administration, more than 75% of all businesses operate as sole
* Advantages: Simple and inexpensive (start-up costs are low); maximum control.
* Disadvantages: Personal legal liability; limited ability to raise capital; succession issue.
2. Partnership. A business with more than one owner; divides profits and losses among participants.
It's most appropriate for lawyers, doctors, and
other professional service providers, but not for most new businesses.
3. Incorporation. A likely choice for businesses with employees or bank financing. It costs $500 to $1,000
or more for attorney and fees. A corporation is a state-chartered organization owned by shareholders.
The shareholders elect a board of directors who are ultimately responsible for management of the business.
There are two forms of for-profit corporations (see below).
* Advantages: Personal assets are protected if the business fails or is sued.
* Disadvantages: Taxes on profits are potentially higher than with sole proprietorship.
S corporation. So called because it is under subchapter S of the Internal Revenue Code; known as a Sub S.
* Advantages: Most appropriate
for start ups; limits personal liability; eliminates double taxation.
* Disadvantages: Taxes on many
fringe benefits; limits on retirement benefits; restricts number of
stockholders to 35.
C corporation. So called because it is taxed under regular corporate income tax rules.
* Advantages: Limited liability;
access to capital (can raise money through sale of stock); perpetual
(unlike sole proprietorship); ownership can be transferred.
* Disadvantages: Profits are
subject to double taxation (corporate income is taxed, and then
paid to stockholders are taxed as
part of the individual's income); regulation and paperwork; start-up
including legal and filing fees.
4. Limited liability company (LLC). State chartered organization that allows for the reduced personal
liability of a corporation, but with the tax advantages of a partnership.
* Advantages: Liability
protection; no "member" restrictions; no double taxation; easier access
(compared with partnership).
* Disadvantages: Tax and
liability benefits vary from state to state; high costs of start up.