When you are ready to start your own business, you may initially have questions about what the best way to legally structure it would be. The most common business structures within the U.S. are sole proprietorships, LLC’s, S Corporations and C Corporations. Understanding each of theses structures will help you to select the best option for your business goals and needs.
Sole Proprietorship
To establish your business as a sole proprietor requires no legal paperwork and is most often created when an individual wants to do business in their own name. When you are running a business as a sole proprietor, there is not a distinction between you and a legal entity; in this instance they are one and the same.
One of the advantages of establishing a business as a sole proprietorship is that is it a simple process that does not require legal paperwork and there aren’t any annual corporate taxes to be filed. There are several disadvantages to working as a sole proprietor:
- No legal protection for your personal assets in the event of a business default or a lawsuit
- The business and personal risks will expand as the business expands
- There can be substantial challenges to raise capital when you are a sole proprietor.
Limited Liability Company (LLC)
An LLC is a formation that is often a popular alternative for business owners who are not interested in establishing a corporation. LLC stands for limited liability corporation and it offers some liability protection for the owner, although the legal barrier is considered to be thin between the business and the business owner. An LLC is generally the most suitable for smaller companies who have either one owner or a very small number of owners.
The advantages of an LLC are that they have much less administrative paperwork than a corporation and they offer a pass through taxation to the owners. The disadvantages of establishing an LLC are that in some states there is an imposed franchise tax and also that it can often be very challenging to raise capital as an LLC.
S Corporation
An S Corporation falls under the subchapter S of the IRS tax code and is the most common structure for small business owners to develop. An S Corporation does not pay income taxes but passes its taxes through to its shareholders who have to claim them on their own personal income tax returns. A corporation must request after being formed to become an S class and a request must be sent to the IRS to receive the designation. S Corporations cannot have more than 100 shareholders, spouses being counted as one. S Corporations can only issue one class of stock.
C Corporation
C Corporations are similar to an S Corporation in most ways with the most notable differences being in the form of taxation and the number of allotted shareholders. A C Corporation may have an unlimited numbers of shareholders and the corporation in this instance must file and pay its own income taxes. C Corporations can have multiple classes of stock.
Incorporating Your Business
Now that you have information to help you to decide which structure is most suitable for your personal needs, you need to actually create the paperwork and file it with your state. The legal paperwork can be created by you, by an attorney or by an incorporation firm. In my personal experience it is worth hiring an attorney to complete, as you may make mistakes if you do it on you own. Also, incorporation companies are typically less personal than an attorney and are generally more expensive.
The Cost of Incorporating
When you work with an attorney, most LLC paperwork will cost between $250-500 for each formed with Corporation paperwork having a cost between $1000-4000+ to establish.
If you are on a budget and prefer to have a lawyer complete and file it for you, there are many attorneys that are new who will work at a much lower hourly rate than an experienced attorney. While you can print forms off the internet to fill in, if there are mistakes or they are improperly filed, you could run into substantial problems in the long run.
Whichever approach you decide to take, establishing the business structure is one of the first steps that a new business owner must complete.