September 18, 2018

Choosing a Legal Structure

The most common legal structure for small business is a Sole Proprietorship for entities with only one owner or a General Partnership where there are two or more owners. Both of these legal entities make good horse sense when you are just starting out in a typical home-based business and personal liability is not a big concern.

Sole Proprietorship and General Partnerships are the most popular as they are the least complicated and expensive to establish. Both, however, have the main drawback that the business owners are personally liable for business debts. This is a significant drawback as it both limits your ability to establish separate business credit lines for your home-based business and holds you personally liable for any and all debts including but not limited to judgments from lawsuits.

If you are concerned at all about the potential liabilities your business may incur or think that you will need substantial lines of credit to adequately fund your home-based business, you should give due consideration to forming either a Limited Liability Company (LLC) or a Corporation.

A LLC or Corporation may seem a bit over the top for you if you have what you deem to be a simple work from home business. They are both more complex and costly to form, but they do have substantial advantages.

The main feature that attracts even simple work from home businesses like yours to form LLC’s or Corporations despite the increased complexity and costs associated with them is the limitation of the owners’ personal liability with respect to business debts or lawsuits. Both the LLC and Corporation, if properly established, can also offer more amicable tax treatment.

Generally speaking, the LLC is the logical choice for most small business owners as it tends to provide more flexibility than a Corporation especially when you have more than one owner.

A summary of the entities discussed is included below as a recap:

***Entity: Sole Proprietorship***

Pros: Simple and commercially attractive to form and operate. All profits or losses are reported on your personal tax return.

Cons: Owners are personally liable for business debts and law suits against the business

***Entity: General Partnership***

Pros:
Simple and commercially attractive to form and operate. All profits or losses are reported on the partners’ personal tax returns.

Cons:
Partners are personally liable for business debts and law suits against the business.

***Entity: Limited Liability Company (LLC)***

Pros:
Limits the personal liability of owners with respect to business debts, profits or losses may be allocated differently than the owners’ business interest, and IRS regulations allow a choice to be taxed as either a partnership or corporation.

Cons:
More costly to create than Sole Proprietorships or General Partnerships.

***Entity: C Corporation***

Pros:
Limits the personal liability of owners with respect to business debts, benefits (ie. Health insurance, 401K etc.) are deductible as business expense, and owners may distribute profit across the owners and the corporation resulting in a lower overall tax rate.

Cons:
More costly to create than Sole Proprietorships or General Partnerships, required paper work can prove burdensome, and it is a separate taxable entity which results in more paperwork.

Do your research, look at all of the advantages and drawbacks of each entity as they apply to your home-based business, and consult a legal and tax professional for advice prior to making your final decision. Being well informed before you consult your professional legal and tax advisors will result in both lower fees and a more appropriate result.