How should you structure your business?
It’s the same question faced by all entrepreneurs when they first start out: How should the business be structured? And if you’re thinking about forming a business entity, it’s one of the first decisions you’ll face too.At the state and federal levels, businesses are subject to regulations that affect how they are formed, how they operate, how they’re taxed and how liability is apportioned. So to choose the structure that maximizes advantages while minimizing costs, you’ll need to be familiar with regulations at both government levels. Some states offer incentives to attract new businesses; others have gained a long-standing reputation for being friendly to businesses of all types.
To get you started, contrast and compare these common structures used by small businesses:
Sole Proprietor: The simplest and least protective of all options. As the name indicates, your business can’t take on partners or sell ownership shares. You don’t need to draft articles of incorporation or register the business with any state, though many municipalities require a license to operate under certain conditions. You also get no personal protection against liability if something goes wrong—like a lawsuit from a disgruntled customer. At the federal level and in most states, business taxes for a Sole Proprietorship are calculated on your personal income tax using IRS Schedule C. That means your business will be taxed at the same rate as your personal income.
C Corporation: Compared to a sole proprietorship, C Corporations occupy the other end of the spectrum in terms of liability protection. From both legal and tax perspectives, a corporation is a separate entity from its owners. Shareholders (owners) elect a board of directors who oversee management and operational functions, which are performed by employees and/or contractors. You’ll need to file articles of incorporation with your state, pay filing fees, and submit annual reports and other documents on a regular basis. You can keep the corporation private or sell stock publicly to raise capital. Corporations pay federal, state and even local taxes on the profits they earn after deducting expenses. If you and other shareholders receive a portion of those profits in addition to your salary, you’ll pay taxes on your share—in addition to income taxes on any salary earned. A C Corporation is the type of business entity used with Pango Financial’s DreamSpark® plan.
Limited Liability Company (LLC): An LLC reduces the potential liability of its individual owners while still providing some of the benefits of incorporation. You can choose to be taxed either as a partnership or as a corporation. If taxed as a partnership, each owner’s share of income, expenses and profits/losses is reported on their individual income tax return; if taxed as a corporation, the company stands separate from its owners for tax purposes. Either way you’ll need to file incorporation papers, pay appropriate fees and get licensed in the state where the LLC is located.
Partnership: In this type of structure, two or more individuals operate the business and share in its income, expenses and profits. Partners are considered owners, not employees, and they must report their share of the entity’s finances on their personal tax returns. Partners also share proportionately in any liability incurred by the business (i.e. from a lawsuit). A formal partnership must file a financial statement every year to all partners and the IRS, using form K-1.
S Corporation: Similar in many ways to a C Corporation, an S Corporation pays taxes in a way that’s similar to a partnership. Shareholders report their portion of the corporation’s income, expenses and profits on their personal income taxes. This business structure must also meet a series of IRS requirements: There can be no more than 100 shareholders, and they must all be individuals; all shares of stock must be of the same class; the business cannot do business as a financial institution or insurance company; the corporation must be established in the US.
The structure that works best for your business entity will depend on a wide range of factors, including the location, type of product or services it sells, the financial goals and resources of its founders, and the entity’s growth projections.
At Pango Financial, our small business professionals can walk you through the details and help you secure financing to get your business off the ground. Contact us at Pango Financial or call 1-855-WHY-PANGO (1-855-949-7264).