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Business Structure
Before you start your business you will need to consider business structure. The business structure you choose will depend on a few factors: how many owners your business has, the type of business, the types of activities your business will be engaging in, and the financial situation of your business.
The type of business structure you choose will effect your taxes and how you meet other government requirements. Not every business structure will fit every business so this decision must be carefully thought out.
The Small Business Administration has a great tutorial about business structure that can further help you decide which structure is best for you.
Sole Proprietorship~Partnership~Limited Liability Company~C Corporation~Subchapter S Corporation
Sole Proprietorship - A sole proprietorship is one of the easiest business structures for a new business owner. There are no forms to fill out, you don't have to register your business structure with the state and you don't have to follow any special operating rules. All you have to do is open your business! In essence, sole proprietorship is the default business structure for a person who goes into business for his or herself.
It is important to remember that as a sole proprietor, your business is indistinguishable from your self. You will file taxes with your personal income taxes. You will also be liable for any judgments brought against your business. If you are in a risky field, like stock trading, or any industry that sees a lot of lawsuits, being a sole proprietor may not be a wise decision.Partnerships - Partnerships are very similar to sole proprietorships. There are no special forms, registrations or rules in most states. However, some states do require you to file a partnership agreement. A partnership begins when 2 or more people start a business together. The partnership structure is the default business structure when 2 or more people go into business together.
Also like sole proprietorships, both partners will report their share of the income or debts on their own income tax returns. Both partners are also wholly responsible for all debts and judgements owed by the business.Limited Liability Company (LLC) - LLCs combine what's great about corporations and sole proprietorships. An LLC gives you limited liability which means you as the owner are not personally responsible for debts or judgements of the company. There are a few exceptions to this rule. It is most important for you as the business owner to be sure and treat your LLC as a separate entity and not an extension of personal affairs. Some ways to make sure that a judge will perceive that you have kept your business entity separate are to always act in accordance with the law. You should also get an Employee Identification Number (EIN), also called a federal tax identification number, and open a business checking account. Keep your personal money out of the business. Also it is important to create an operating agreement.
Like the sole proprietorship and partnership, the LLC is not considered separate from it's owners when it comes to filing income tax. A single owner will report profit or loss on his or her personal tax returns, while partners will each report their own share of profits or loss on their own personal tax returns.
Forming an LLC is a bit more complicated than forming a partnership. You must file articles of organization with your state government. The name does vary from state to state but it will be basically the same. You will generally file with the secretary of state but this also varies from state to state. Many states will provide you a one page form to fill out for your articles of organization but you may have to create your own. Generally the articles of organization will include the name of your LLC, location, and members names and addresses. The cost to form your LLC can be anywhere from $100-$800.
You should also write an operating agreement. Your operating agreement does not need to be filed with the state but is crucial in laying out what is required from each member in the LLC. It also explains what to do in the death or termination of one of the partners, and how to end the business. An operating agreement also lends credibility to your LLC in the event that you need to go before a judge.
C Corporation - C Corporations are separate legal and tax entities. Corporations pay their own taxes and the owners only pay income tax on money they draw from the corporation, such as salaries and bonuses. Corporations also provide owners with a limited liability for business debts and judgments.Filing for corporation status is similar to filing for LLC status. First you must appoint a director or board of directors. Then you must file articles of incorporation with your state secretary's office. The terms and office may vary from state to state. This costs between $100 and $800 depending on where you incorporate. Next you will need to draft your bylaws and hold your first meeting. You will also need to issue stock certificates to the initial owners of the corporation. Issuing stock can be complicated and must be done in compliance with the Securities Exchange Commission and your state securities agency. This will cost an additional fee but they do offer exemptions to small businesses. Please be sure to throughly research all laws and regulations regarding stock issuance before proceeding with that step. You can find out more information at the SEC website.
Running a corporation is a lot more work than running a sole proprietorship! As the owner of a corporation, you are required to hold shareholder's and director's meetings, maintain corporate records and document major decisions. If you neglect to do these things, a judge could decide you were not acting as a corporation and make you, the owner, liable for all business debts!
Corporations generally have shareholders who elect directors and amend the articles of incorporation and bylaws and directors who set policy and make major financial decisions. Both shareholders and directors are generally required by state law to hold annual meetings. Corporations also generally have officers who are responsible for the day to day tasks, and employees who make it happen. In most states, it is okay for 1 or 2 people to fill all these positions.
It is important to document all major decisions in order to keep your limited liability status. Many corporations keep minutes of all important decision making meetings. This helps keep the IRS and Uncle Sam off your back!