The idea of starting a business is scary enough; then comes the difficult decision of what type of business entity to establish. You’ll need to consider your financial needs, risk and ability to grow. Choosing correctly at the start is critical because it can be difficult to change your legal structure after you have registered your business.
A sole proprietorship is quick and inexpensive to form. You have complete control over your business. You are entitled to all profits from the business. Nonetheless, you are also liable for all business debts and have an unlimited personal liability, which may be undesirable. This type of entity may also make it difficult to raise capital if needed.
A partnership has several options: (1) a general partnership with overall equal division of profits, liability and management or (2) a limited partnership with one partner controlling the operations and other partners with limited roles. Partners must file taxes twice, once for the partnership and once for the individual. Also, if disputes arise between partners, there could be some drama. Similarly, with this type of business, you could be held liable for actions made by your business partner.
A multi-member limited liability company (LLC) is a hybrid between a partnership and a corporation, and it can be taxed as either. This entity provides options for the actual business structure with the limited liability of a corporation and the operational flexibility and tax structure of a partnership.
If liability and outside funding are your main concerns, then a C corporation might be your best fit. A C corporation provides limited liability. Other pros of a C corporation are the ability to generate capital. Plus, the current tax rate is capped at 21%. Conversely, C corporations are subject to double taxation—once when the corporation makes a profit and again when it pays dividends to shareholders. There’s also the accumulated earnings tax, a tax imposed by the federal government on companies with retained earnings deemed to be unreasonable and in excess of what is considered ordinary. Essentially, this tax encourages companies to issue dividends, rather than retain the earnings.
An S corporation is also a good option for limited liability; yet, an S corporation has stricter operational processes including shareholder compensation requirements. On a positive note, this type of corporation eliminates any double taxation since the income is passed through to the shareholders to report on their personal returns.
The best option for you will depend on your personal and business goals and how they align with what each type of entity has to offer. I can help you with this decision - I would rather have you consult with me first before jumping into an entity that isn’t right for you, whether tax-wise or administrative-wise.