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Which type of business organization should I form?

October 24, 2015

Forming a new business is one of the few times in your life that will bring simultaneous feelings of utter excitement and sheer terror. You will inevitably ask yourself the same questions over and over again, each time coming to a different conclusion; “Where will I get customers”, “How much money do I need”, “Will I be able to support my family”. It’s only natural to focus on the unknowns; after all, you’re taking on a responsibility that will undoubtedly change your life for many years to come. However, one topic that may escape your mind is determining which type of organization to create. You may have convinced yourself to start simple as a sole proprietor, or perhaps you went the more extreme route and filed paperwork to form a corporation. Whichever entity type you decided to create (or perhaps you haven’t decided yet), it’s important that you step back and focus on why you want to form a particular type of organization. Fortunately, there are only a few questions you need to ask yourself, and the answers to those should point you in the right direction.

1. What type of liability will I face personally?
Before you worry about profits, shareholders or office space, you must, must, MUST think about liability for your business. Liability isn’t just about making sure the customer is compensated if they don’t get the product or service they expect. Liability is about protecting you, your family and your personal assets. Did you know that as a sole proprietor, every business transaction puts your house, cars, children’s college money and all your other personal assets at risk? Different business organization types have different levels of liability should someone sue your business. Think about the exposure you’re going to face as a business owner; as a restaurant, what if a person gets food poisoning; as a mechanic, what happens if the brakes you just installed fail.

Determination: If your business has a greater degree of liability, you will want to shy away from both sole proprietor and partnerships. Look to an LLC, an S Corp or a C Corp.

2. What are the tax liabilities for my business?
Don’t forget about Uncle Sam, because he certainly won’t forget about you! You should definitely consider how your business organization affects your tax liability. For example, corporations that pay out dividends are actually double-taxed, which can get quite costly. On the other hand, other types have pass-through taxation, which means the profits your company makes go directly to your personal bottom line come tax season. As a start-up, you’ll want to consider how your taxes will be allocated and who will be responsible for paying them. Make sure you save enough money during the year – whether in your personal or business accounts – to cover your tax liability. You may even be required to file quarterly estimates so you don’t get too far behind.

Determination: Unless your forming a C Corp, assume that any profits made by your company (whether you put the money into your personal account or not) will be added to your adjusted gross income at the end of the year – and you will be required to pay taxes on it.

3. What do I have to do to start my company?
Certain entity types are easier to start then others; but often with that ease comes risks. For example, you can start a sole proprietorship before you finish reading this article. In fact, say out loud: “I am starting my business right now”. Congratulations! You just started a sole proprietorship! You don’t have to do anything other than conduct some form of business transactions and you’re officially a company.

However, other types may require paperwork, which may require additional filings with your state. For example, an LLC requires a filing with your state corporation bureau but no formal agreement between the members, while a partnership requires some form of agreement but no filing. Depending on how quickly you need to get started, you will want to look at the requirements for each organization type.

Determination: If you absolutely, positively need to get started today, look at sole proprietorship or partnership. If you can wait a few weeks for the paperwork to go through, look to an LLC.

It can be difficult to precisely identify what organization type your company should form under. Other considerations are how many people will be owners, will you have investors, do you need to issue stock, etc. Keep in mind, you can always start as one type and transfer to another (although additional paperwork and fees may apply).

If you’re not sure what to do, or you have other questions about starting your business, feel free to give us a call and we’ll help you out.

Best of luck in your new business venture!
Mike Terkanian, Esquire.

The following chart gives you a quick summary of the most common business types:

Liability Taxation Ease to Start
Sole Proprietorship Most Risk: Full liability as an individual Pass-Through: All profits are added to your personal gross income Very Easy: Can be started just by doing business
Partnership Very Risky: Jointly liable with your partners; you could also be fully responsible for any claims Pass-Through: All profits are split between partners based on ownership and added to your personal gross income Easy: Form an agreement with at least 1 other party; agreement should be converted to writing
Limited Liability Company (LLC) Minimal Risk: The company is an independent entity who assumes all risks of liability Pass-Through: All profits are split between members based on ownership and added to your personal gross income Medium: Must file a certificate of formation with your state corporation bureau and pay filing fee
C-Corp Minimal Risk: The company is an independent entity who assumes all risks of liability Corporate Tax: The corporation pays the taxes for all profits; any dividends distributed to stock holders are taxed additionally Somewhat Difficult: Must create articles of incorporation, file a certificate of incorporation with your state corporation bureau and pay filing fees
S-Corp Minimal Risk: The company is an independent entity who assumes all risks of liability Pass-Through: All profits are split between members based on ownership and added to your personal gross income More Difficult: Must create articles of incorporation, file a certificate of incorporation with your state corporation bureau, file Form 2553 with the IRS and pay filing fees

DISCLAIMER: The information provided in this post should not be construed as legal advice. It is provided for research purposes to give you basic information on the content contained herein. This post does not create an attorney-client relationship nor should it be used as authoritative. If you have questions regarding the conclusions reached in this post, please call our offices or contact your legal counsel.

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