Choose legal structure carefully

When you start a business you have a lot of decisions to make. Should you work out of your house or rent an office or retail space? If you plan to rent, where is the best location? Which wireless phone plan should you use? What should you get William and Kate for a wedding gift?

With all of these decisions to make, an important issue may get overlooked. What legal structure should your new business take? Give it some thought because your decision will affect your personal liability, your tax bill, and the amount of control you ultimately have over your business.

The simplest form of a business in the sole proprietorship, which is simply an individual owner who has complete control of the business. A sole proprietorship is easy to form and requires no governing documents. Profits and losses from the business flow through to the owner and are reported on the owner’s tax return, so profits are only taxed once. However, the sole proprietor faces unlimited personal liability, so give consideration to the type of business you are starting and the potential risk you could face.

Two or more owners can form a partnership, with general partners responsible for business operations and limited partners usually serving as investors and not actively involved in the business. A partnership does not require governing documents, but a partnership agreement is recommended to formally define ownership percentages and partner responsibilities. As with the sole proprietorship, profits and losses flow through to the owners’ personal taxes. General partners face unlimited liability, while a limited partner is liable up to the amount of his or her investment in the business.

Concerned about unlimited personal liability? Then a corporation may be for you. Forming a corporation requires more work and some help from your friendly lawyer to develop a shareholder agreement, corporate by-laws, and articles of incorporation. The corporation limits the owner’s liability to his or her investment in the corporation, and operating as a corporation makes it easier to raise funds for the business through the distribution of stock. However, profits and losses from the corporation are taxed before they are distributed to owners with any distributions to owners taxed again, albeit at a lower dividend rate.

To avoid this double-taxation issue, corporations can opt for a structure called the S-Corporation where profits and losses flow through to owners without being taxed at the corporate level.

An option for many small businesses that bridges the liability issue and the double-taxation issue is the Limited Liability Company (LLC). The LLC provides limited liability to its owners, while profits and losses flow though to the owner’s tax return. Forming an LLC can be done through the NC Secretary of State website, and maintaining an LLC does require filing annual reports with a fee of $200 per year.

So how do you determine which structure is right for you?

Take into account the type of business you’re starting and consider the potential liability issues, as well as the cost of forming each business. And talk with your accountant to make sure you know how your business profits or losses could impact your tax bill. Your legal structure is an important issue, so do your research before making a decision.

Do you have a business question or topic that would make a good column? Send your ideas or questions to jeff.neuville@b-assistnc.com and share your business experience with others.