Choosing the right structure for your business is important for several financial reasons. It is also an important decision from convenience and legal perspective as well. It will determine how you should pay your taxes, your personal liabilities, and how you can generate capital for your business.
Thankfully, even if you have chosen a corporate structure already, it can still generally be changed if a different structure would work better. Consider the following items when deciding the right corporate structure for your business.
Risks and Liabilities
Limited liability entities have a lot of advantages from an asset protection standpoint. If your business has the potential for liability, shielding your personal assets from your business activities is always a good idea. It can be difficult to determine which types of businesses may be more prone to liability than others, so you should err on the side of asset protection when you are unsure.
If your company trades stocks, does home construction or creates a product, a structure that allows for liability limitations is likely a good idea. A corporation, limited liability company (LLC), or a limited partnership may all be good structures to consider.
Don’t gamble with your asset protection. Choosing the right business structure can help.
Some structures have certain tax advantages over others. Nonetheless, having any type of business will have tax advantages over simply filing an individual income tax return. However, corporations sometimes get a negative reputation for “double taxation.” That is, they are taxed as a separate entity and then the income that the owners derive from the corporation is taxed a second time on their individual tax returns. While these taxes may still be less than individual taxes, they can be a burden that may be avoidable by using a different structure.
Choosing an S-corp structure (in contrast to a C-corp) can allow you to have the other benefits of a corporation without having to deal with double taxation. An S-corporation is a pass-through entity. That means that all the income and expenses are expressed on the individual tax return instead of on a separate, corporate return. Income taxes for an S-corp end up looking similar to a partnership tax return.
Limited liability companies, partnerships, and even sole proprietorships also have tax advantages that can help decrease your overall tax burden. However, sole proprietorships are up to ten times more likely to be audited!
Formation and Administration
Some structures have more legal and formal requirements than others. These requirements often have administrative costs associated with them as well. Because you have to stay on top of these regular requirements, you should consider the time and money necessary to maintain your corporate structure.
For example, corporations have certain record-keeping and paperwork requirements that often need to be met on an annual or biannual basis, depending on the state in which you have incorporated. These filings often have fees associated with them as well. You may be required to hold regular meetings and keep the minutes of those meetings. State laws also often require that you keep certain records for a period of several years as well. Owners can waste valuable time doing administrative tasks that he or she may not have to do if their business was an LLC or partnership.
The paperwork and administrative costs of a corporation can be too much for some smaller businesses to handle effectively.
The formation itself also costs money, which can be a turn-off for some business owners. Nonetheless, corporations can be valuable for asset protection or a tax decrease, so it is important to weigh the pros and cons.
Your business may start out as a partnership or sole proprietorship, but as it grows, a corporation or LLC may make more sense. Planning ahead can curb issues that creep up in partnerships or other more informal business structures.
For example, corporations and LLCs are more conducive to transition planning. It is much easier to just change the names of owners on a piece of paper compared to transferring significant assets from one individual to another as you would have to in a sole proprietorship and some partnerships. In most corporate structures, there is a plan in place if a member passes away suddenly or retires, but this is not always the case in more informal structures.
Corporations are also the most conducive to allowing others to invest in the company. If your major source of income comes from investments from others, incorporating may be the easiest way to structure those investments. Issuing shares to investors is often an easier solution than bringing them in as a partner. An LLC allows for similar investment options that may be less regulated as well.
Choosing the Right Business Structure
Ultimately, the right business structure for you will depend on the type of company you have and your goals. Every company is unique and choosing the right structure requires taking a hard look at the company’s current financial status and future needs. Protecting assets, reducing taxes, and having a flexible structure are common goals.
Find out more about various business structures and how to take advantage of each type of structure by using the extensive resources at Protect Wealth Academy. Sign up for a free membership.