Once you have made a decision to start your own business you will have to think about which business structure (or business entity) your business will use. Your business structure will determine which types of income tax returns you'll have to file as well as other legal and tax considerations.

Each business structure has its advantages and disadvantages; it is important you review them carefully so you make the best decision. It is always a good idea to consult with a CPA (Certified Public Accountant) or attorney.

The following is an overview of the different types of business structures.

Sole Proprietorship

A sole proprietorship is a business that is owned by one individual. As a sole proprietor, you'll have total control and ownership of the business. A sole proprietorship is the simplest form of business organization to start and maintain, which is why most new small businesses use this business structure.

Under a sole proprietorship, the business' liabilities are your liabilities. In other words, you assume all the risks of the business. You're personally liable for all business debt, and the liability is not limited to the value of the business—this means your personal assets are at risk.

While a sole proprietorship is simple and inexpensive to form, you are still subject to some fees that all businesses must pay; Such as business licenses, sales tax, and other local and state fees and taxes.

Advantages of a sole proprietorship:

• Simple & inexpensive to form.
• You have total ownership & control.
• There is no ‘double taxation.'
• Minimal record keeping other than for tax purposes.

Disadvantages of a sole proprietorship:

• All of your personal & business assets can be risk.
• Often difficult to obtain business loans.
• A sole proprietorship is limited to one owner.

LLC

A Limited Liability Company (LLC) is a popular business structure. LLCs have the tax benefits of a partnership, and the limited liability benefits of a corporation.

Limited Liability Companies are formed by completing and submitting the required documentation (Articles of Incorporation), and paying the required fees. The owners of an LLC are called ‘members' and there usually can be only one member, however some states require a minimum of two members (Massachusetts). In most states, members may include individuals, corporations, and other LLCs.

There are some businesses that can't be LCCs; you will want to check with your state to see if you're eligible.

Advantages of a LLC:

• Limited Liability – if the debts of the company exceed its assets, the creditors cannot come after your personal assets.
• There is no ‘double taxation' – profits & losses of the business are not taxed at both the LLC level & personal level like a Corporation is. With a LLC, profits & losses pass through to the owner's tax return, and are only taxed once.
• Less record keeping – you don't have to hold shareholder and director meetings.
• More than one class of stock is permitted.

Disadvantages of a LLC:

• A lot of paperwork, and complex to setup. Legal assistance may be required.
• Limited Life – an LLC is dissolved when a member dies or leaves. However, this can be amended in the operating agreement.
• The LLC is a newer entity and customers are not as familiar with it as they are a corporation. There might be a perception among some customers that a business name with “Inc.” at the end is more professional and stable than an LLC.

Corporation

The corporation is a taxable entity which exists separately from its owners. The corporation's profits are taxed at two levels: the corporation level, and the personal level. This is called “double taxation.” In other words, the profit is taxed to the corporation when it's earned, and then taxed again to the shareholders when the profit is distributed as dividends.

One advantage of a corporation is that the owners (shareholders) of the corporation have limited liability. This means that the owners are not personally liable for the corporation's obligations; they only risk what they have invested in the business.

Incorporating your business will usually make it easier to establish credit from suppliers and receive loans from banks.

Advantage of a corporation:

• Limited Liability – if the debts of the company exceed its assets, the creditors cannot come after your personal assets.
• Generally easier to establish credit and obtain loans.
• Corporations do not dissolve upon death of an owner (stockholder) or if ownership changes.

Disadvantages of a corporation:

• Double taxation
• Recurring annual corporate fees
• They are more expensive to create than a partnership or a sole proprietorship.

S Corporation

Any eligible corporation located in the United States can avoid double taxation (once to the shareholders and again to the corporation) by electing to be treated as an S Corporation.

If you are an S Corporation you may be liable for:

• Income Tax
• Estimated Tax
• Employment Taxes
• Excise Taxes

If you are an S corporation shareholder you may be liable for:

• Income Tax
• Estimated Tax

Advantage of a corporation:

• Liability of the owners is limited to their investments.
• There is no double taxation as with a regular corporation.

Disadvantages of an S corporation:

• They are more expensive to create than a sole proprietorship or partnership.
• Only smaller companies may acquire S Corporation status.

General Partnership

A partnership is the relationship between two or more persons who join together to form a business. Each partner contributes to the business and expects to share in the profits, losses, and liabilities.

A partnership must report the income, deductions, profits, losses, etc., from its operations, but it does not pay income tax. Instead, the profits and losses “pass through” the partnership to its partners. Each partner then includes their share of the partnerships profit or loss on their tax return.

A partnership is usually created with a “partnership agreement”. When forming a partnership, you will want to make sure everything is done right, because after all, you're liable for the other partners and they are liable for you. It is usually a good idea to consult with an attorney before you form your partnership.

Each partner risks their personal assets, and is liable for the other partners.

A partnership must have two or more persons. There isn't a limit on the number of partners the company can have, however, a partnership with many partners is usually more difficult to manage and make business decisions.

Advantages of a partnership:

• There is no double taxation.
• Liability is spread among the partners.
• Investment money comes from partners.
• Relatively easy to form and less expensive than a LLC or corporation.

Disadvantages of a partnership:

• Problems with partners because of different goals, ideas, misunderstandings, etc., can destroy the partnership.
• The owner's personal assets are not protected from the business.
• Your partners can commit the business to contracts and deals that you are personally liable for.
• Partnership is usually dissolved when a partner dies, however, this can be amended in the partnership agreement.

Limited Partnership

A limited partnership is similar to a general partnership; however, there are two types of partners, instead of one. The two types of partners in a limited partnership are:

1. General partners
2. Limited partners

General partners are partners who manage the business and have the same risks and liabilities as partners in a general partnership.

Limited partners are partners who contribute money to the business and do not manage it; they just contribute money. Limited partners have no liability for the business's debts.

A limited partnership is created by filing a Certificate of Limited Partnership with your state, and paying the required fees. As with a general partnership, there must be two partners to form it. However, unlike a general partnership, you must have one general partner and one limited partner to form a limited partnership.

Advantages of a limited partnership:

• A limited partner risks only their investment and no personal assets.
• A limited partner shares in the profits without risking personal assets.

Disadvantages of a limited partnership:

• A general partner still risks their personal assets and has the same liability as in a general partnership.
• There is still potential for conflicts between general partners, which could destroy the partnership.
• More complicated than a general partnership.

Choosing your business structure is a very important decision and can affect the way your business works. You will want to become familiar with the different types of business structures and consult with your CPA or attorney if you have any questions.

To your success.