Your legal structure is more critical to your business than you may expect. In addition to influencing your tax burden, it may also impact your liability.
This brief guide will help you understand how different business legal structures work. You can use these details to help determine which would fit your business the best.
What Is a Business Legal Structure?
The legal structure of your business refers to the government classification that determines various matters with regard to your business. The format can influence the following:
● The taxes you will owe
● Liability considerations
● The formation processes
● How to distinguish between the individual and the business
Understanding the Common Business Legal Structures
There are four major business legal structures to explore when managing how your business operates. Here is a closer look at each of these options.
1) Sole Proprietorship
A sole proprietorship involves one person. It does not create separation between the owner and the business.
A sole proprietorship pays taxes through the owner’s personal tax return. The business does not file a separate tax return in this case.
The owner of the business is also personally liable for all operations, meaning you could be sued for anything that happens within your business.
Forming a sole proprietorship is easy, as it entails filing a certificate with your local entity and acquiring an employer identification number. You may need to acquire certain licenses and permits, but the rules can vary by location.
2) Partnership
You can establish a partnership with other people. A partnership involves many people working in the same business but with rules for how much of the entity they own, how they share profits and losses, and management rights.
The group doesn’t pay federal income tax, but it must record income and losses. The owners will receive their profits and losses based on the profit-sharing percentages they agree to, with each partner paying their share of taxes.
There is little paperwork involved in forming a partnership. You’ll need to draft your articles of the partnership agreement and obtain a business license in most situations. The agreement must cover management duties, bookkeeping and banking, and dissolution rules.
3) Limited Liability Company
A limited liability company or LLC will protect all business owners from personal responsibility for any debts or liabilities it incurs. An LLC ensures the owners’ personal assets cannot be pursued in any situation. Profits can also go towards the owners as personal income, ensuring double taxation of the company and its owners will not happen. An LLC must have articles of organization and then pay a filing fee with a local government to start. An operating agreement listing member rights and voting powers, how you share profits and losses, and how the management structure works will also help.
4) Corporation
A corporation is a structure separate from the people who run it. A corporation can enter different contracts from what the shareholders have. This option works best for larger companies that operate in many places and have multiple employees.
A board of directors is necessary for establishing a corporation. The process for doing this is more extensive and costly than usual.
What Should You Consider?
There are many points you should look at when determining which business legal structure is ideal for you:
● How many people will be in your business? A partnership may work best for smaller entities.
● Do you have concerns over personal liability? An LLC or corporation can help you avoid personal liability.
● What taxes are you more comfortable managing? A sole proprietorship or partnership can provide a simplified approach, but each business will have different needs. Getting advice from a tax professional is best.
● How will your business expand over time? You might require a more extensive legal structure if you plan on growing your business any further.
Your business legal structure can influence your group’s operations and what you can expect from a legal setup. Be sure you know what is happening with your business when setting up your structure and that you’re in a situation you are confident about managing.
