Setting up a small business can be hard enough, especially when it comes to what type of entity you should select. Is it better to be a corporation? A partnership? What about a Limited Liability Company (LLC)? Or even an S-Corporation?
Which Small Business Legal Structure Should I Choose?
Not to sound evasive, but it really depends on what you want to achieve. Each entity has its pros and cons. You must decide what the most important thing to you is and then select the entity structure that fits your goals. While it’s easy to become overwhelmed by the onerous nuance of pros/cons lists (and this one can get long and confusing), the following summarizes the differences in more general terms.
Corporations are best if you want to raise capital from investors and/or offer stock options to employees. The tradeoff for this benefit is that you will pay more in taxes – by quite a bit – and there’s a lot of paperwork to keep up with. Profits are taxed twice: once at the corporate level and then again at the individual level.
Partnerships are best if you want to avoid the double taxation of a corporation and the flexibility to payout profits based on a unique payout scheme. For example, one partner could contribute 10% of the capital but get paid out 50% of the profit. You get to decide the rules in the partnership agreement, and it provides extreme flexibility. The downside is that your personal assets are on the line and at risk.
Limited Liability Companies (LLCs)
LLCs are best if you want something that’s easy to establish and has minimal paperwork. The downside is it’s confusing to figure out how it’s taxed. An LLC is mainly just a regulatory classification with the state. It can be taxed like a corporation, partnership, S-corporation, or sole proprietor. The good news with this one is you get to decide how your business is taxed. The downside to that is you then have to follow the rules of your decision.
S-Corporations are a hybrid of a partnership and corporation. An S-corp provides the tax benefit of a partnership and the legal protection of a corporation. There are restrictions to qualify, but the tax savings could be substantial. The downside is the restrictions on the flexibility of sharing profits. You cannot have stock options and all owners must share the profits in proportion to their ownership percentage.
Hopefully, this provides you with at least a little clarity to get you started as you think through the structure of your business setup. One of the biggest factors in your decision will be the tax implications and our experts at Tax Time CPAs can help walk you through each scenario to find the best fit for your business. Schedule a Discovery Call with us so we can explore the right fit that will help you achieve your long-term goals.