Choosing a Business Structure | High Swartz LLP

[author: Angela Lorenz]

Starting your own business can be rewarding and energizing. And yes, it can be a little stressful. You have many critical decisions to make during the critical start-up phase. One of the most important decisions is choosing a business structure.

It is best to seek the advice of an accountant, business advisor and business lawyer when making a decision. The structure of your business impacts day-to-day operations, taxes, personal responsibilities, how you fundraise, and more. So when choosing a business structure, do it wisely.

Factors that determine your business structure

You can choose several options when setting up your business, including sole proprietorship, partnership, limited liability company (LLC), or corporation.

Which one you select depends on several factors:

  • Flexibility: Determine your expectations for business growth and make sure your structure provides enough flexibility to accommodate that growth. Generally, an LLC offers the most flexibility for growth potential.
  • Responsibility: You will need to consider the risks and your potential personal liability. You will also need to consider insurance, credit and assets. For example, corporations offer the most liability protection.
  • Taxes: Sole proprietors, partnership owners, and S corporations classify income as personal income, while a C corporation separates business income from personal. Your structure has an impact on the tax burden because business income is taxed differently than personal income.
  • C-operationcosts: Keeping up-to-date records and documents can be expensive, so you’ll need to factor in those expenses as well. Sole proprietorships are generally the type of business requiring the least amount of time and money invested in record keeping.
  • Fund raising : Your structure dictates how you fundraise. For example, sole proprietorships generally cannot offer shares, but corporations can.
  • Control: A sole proprietorship is usually the best route if you want complete control over the business. However, you also assume full responsibility for any lawsuits, taxes, and potential losses.

After choosing your business structure, can you change it?

The answer is yes. In fact, it happens quite often. For example, many businesses move from a simple structure like a sole proprietorship or partnership to a more complex structure like an LLC or corporation.

A change in business structure can occur for a number of reasons:

  1. Personal responsibility: As businesses grow, so do the risks. Therefore, a sole proprietorship may want to remove liability by moving into an LLC or corporation.
  2. Taxes: Typically, tax considerations are the primary motivating factor for a change in business structure. For example, the IRS considers businesses as partnerships or corporations. The latter pays taxes on profits before distributing these profits to shareholders. However, the former is a flow-through entity where profits and losses flow through individual partners and require reporting on tax returns.
  3. Attract investors: Venture capitalists and angel investors prefer to invest in C corporations for tax purposes. Additionally, a more formal structure like a corporation or LLC establishes the business arrangement in advance and what the options are.
  4. More employees: As your number of employees increases, the debts attached to them also increase. So going from a sole proprietorship to an LLC or a C Corporation protects you.
  5. Funding: Many banks want to see a more formal business structure before providing financing.

Changing your business structure differs depending on your initial business setup. For example, going from a sole proprietorship to an LLC, partnership, or corporation requires registration with the state where you do business.

You’ll want to create an LLC operating agreement when changing to an LLC. Going to a corporation requires the selection of officers, a board of directors and shareholder agreements.

You’ll want to hire a business lawyer to help you sort out the details and make sure you handle all the requirements of the business structure change.

What are the types of business structures?

The legal formation of your business is governed by the law of the state where you are establishing your business. Your decision should consider liability, taxation and record keeping.

The most common forms of corporate structures are:

  • Sole proprietorships
  • Partnerships
  • Limited liability companies (LLC)
  • Companies

So let’s take a closer look at what to select when choosing a business structure.

Individual business

Generally, this option is the simplest and most common. With a sole proprietorship, your business is unincorporated and run entirely by one person – you as the owner. While this structure entitles you to all profits, you are also individually responsible for all debts and liabilities.

You get the necessary licenses and permits for your business when you operate a sole proprietorship. However, they vary by state and industry. Additionally, if you operate under a trade name, you may be required to legally register a fictitious name.

In many states, such as Pennsylvania, registering a fictitious name does not protect the name or give you the right to prevent others from registering the same fictitious name. Instead, it only serves as notice to the public that you are trading under that name. Additionally, you must file an Employer Identification Number (EIN) with the IRS if you hire employees.

Because you are the sole owner, your business entity is not taxed. Instead, you report income and losses on Annex C to Form 1040.

Partnerships

A business is legally structured as a partnership when two or more people share ownership. Accordingly, each associate contributes to some aspect of the business and shares both the liability and the revenue.

By choosing this business structure, developing a legal framework Partnership Agreement is essential for documenting how you will make future decisions. In addition, the contract should include terms for dissolving the partnership if necessary. Although a legal agreement is not required, it is strongly encouraged because operating a business without one is risky.

If you choose a general partnership structure, you can form a general partnership. Therefore, everything is divided equally between the partners. On the contrary, a limited partnership allows a partner to have limited liability.

You can register state partnerships with an established business name and all licenses and permits. The business must also register with the IRS and file an “annual information return” to report its income and losses.

The business itself does not pay income tax. Instead, profits and losses are “passed on” to partners.

Limited Liability Companies

An LLC, or limited liability company, is a legally recognized business structure that combines corporate and partnership aspects.

To form an LLC, you must first choose a name that complies with state rules. The next step is to file articles of incorporation with your state’s corporate filing office, usually with the Secretary of State. They are usually short and simple documents that only take a few minutes to complete.

After filing with the state, it is imperative to work with a business attorney to create an LLC operating agreement that sets out the legal rules for ownership and operation of the business.

Finally, be sure to obtain all required licenses and permits. Additionally, some states may require you to post a notice that you intend to form an LLC in a local publication.

Companies

Becoming a legally recognized company is more complex. First, states determine the formation of societies. In addition, corporations pay corporate income tax at the federal and state levels.

Some small companies may choose Subchapter S status and be taxed as a partnership, avoiding corporation tax. In this case, profits accrue to shareholders as ordinary income.

In a corporation, the business becomes a legal entity, and the corporation is taxed and held legally responsible for all business liabilities.

The business must first choose a corporate name that is not used by another corporation or limited liability company and prepare and file articles of incorporation to become a corporation in the Commonwealth of Pennsylvania.

Pennsylvania corporations also need an agent for service of process in the state who is willing to accept legal documents on behalf of the corporation. However, a company with a Pennsylvania address does not need to have a separate agent to handle the process.

To meet the legal requirements for setting up a company, you must publish a legal advertisement, create company articles of association and hold a board-type meeting.

You can learn more by checking out A Guide to Business Registration in Pennsylvania.

Which business structure should I choose?

This answer depends on your business, current ownership structure, and goals. You must assess your individual needs and choose the appropriate business structure.

It is best to speak with business experts and a business lawyer near you to guide your selection. They can also make sure that you complete all required documents and file them appropriately.

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