Have an idea for a business? How do you start transforming that idea into reality? Determining business formation and structure is one of the first and most important steps to starting a new business. The form of business entity can make a difference in terms of taxes, liability, profitability, growth, and more. Getting it right from the very beginning is critical.
At the Law Office of Jennifer M. Settles, we will review your business idea with you and advise you on your legal options. From that point on, we'll will guide you through the process, proactively making sure you have all the forms, documentation, and other necessary information and strategies in place for a successful venture. Contact us today to schedule a FREE initial consultation
How Do You Form a Business?
When forming a business, one of the first and most important decisions to make is the structure you will use. A business structure is the legal classification of a business that determines taxes, liability, and other legal rights and responsibilities.
Different business structures are available, including:
- Sole proprietorship
- General partnership
- Limited partnership
- Limited liability company (LLC)
The best business structure for your business depends on a range of different factors.
Factors Which Influence Business Formation
Here are some factors to consider when choosing the best structure for your business.
A major deciding factor when structuring your business is often the degree of control you want to retain over your business. This is especially true where multiple owners will be involved.
A sole proprietorship allows for full control. As the only owner and operator, sole proprietors can run their business how they want to. In comparison, corporations are answerable to shareholders who elect a board of directors to manage the organization's day-to-day business. As an additional alternative, many people seek the flexibility available under a limited liability company structure. LLCs are governed under the terms of an LLC operating agreement, which allows the co-owners to designate the terms of governance and other attributes within the operating agreement.
2. Limiting Liability
Your business structure also determines the extent of your personal liability for the liabilities, debts and other obligations of the business. Some structures offer better protection against personal liability than others.
In a sole proprietorship, for example, the owner is personally responsible for the business's liabilities and debts, as there is no legal separation between the individual owner and the business. As a result, the personal assets of the owner are available to satisfy the business's debts, and the owner can be sued in his or her personal capacity in relation to the business's activities.
In comparison, in a limited partnership, LLC or corporation, partners, members and shareholders, respectively, have a separate legal identity from that of the business, and, as a result, their personal liability is typically limited to their investment in the business. This limitation of liability is a key reason why people form legal business entities as their preferred structure, as opposed to operating their business as a sole proprietorship.
PRO TIP: Statutory limitations of personal liability notwithstanding, if a legal entity is not formed or operated correctly, a legal theory known as "piercing the corporate veil" or "alter ego" could eliminate the liability shield otherwise available to the owners of limited partnerships, LLCs and corporations. See our free business guide for more details on this topic.
Its always wise to contact a qualified business attorney to ensure that your set-up and operations are optimal from a liability-limitation perspective. Contact the Law Office of Jennifer M. Settles today at 602-617-3938, or through the Contact Form on the website, www.jsettleslaw.com for a free consultation.
The structure of a business determines the applicable tax regime. Many business structures – sole proprietorships, partnerships, limited liability companies, and S-corporations – are pass-through entities. This means the business doesn't separately pay tax. Instead, the tax liability and other tax attributes of the entity are passed to the owners who pay taxes on the business profits via their personal tax returns.
A C-corporation, on the other hand, is treated as a separate entity from its owners for tax purposes, and is taxed according to the relevant corporate taxation rate. Then, when the corporation pays dividends to its shareholders, the shareholders must pay taxes on those dividends in their own personal tax return. The C-corporation tax structure, in which the corporation itself is taxed on its income and the shareholders are subsequently taxed on their dividend income, is often referred to as “double taxation” and is a primary reason why the C-corporation structure may not be the best approach for a small business.
LLCs are popular because, among other flexibilities, they allow the owner to select its federal tax structure. Since 1997, to simplify the IRS's federal tax classification, "check-the-box" regulations allow the LLC owners to select whether the LLC will be taxed as a partnership (which is the default tax treatment if no election is made), a C-corporation or an S-corporation. Assuming the applicable requirements are met, an S-corporation election can be beneficial for a small business in certain cases, in that it allows for a business deduction for "reasonable" salary paid to the owner, with only the salary component (as opposed to all profits) being subject to self-employment taxes. A qualified tax specialist should be consulted in determining tax elections for an LLC.
The degree of administration of a business typically becomes more onerous as the complexity of the business structure increases.
Sole proprietorships and partnerships typically have the least complex paperwork, if any, while corporations and LLCs typically have annual public filing obligations and somewhat complex paperwork to form and operate the business.
Contact Us Today
If you are considering starting a new business, Prime Legal Freelance can help you make strategic decisions. Contact the Law Office of Jennifer M. Settles today at 602-617-3938, or through the Contact Form on our website, www.jsettleslaw.com, to schedule a FREE initial consultation. We look forward to helping make your new business a successful one.
Jennifer M. Settles, Esq. is a corporate lawyer at the Law Office of Jennifer M. Settles. She advises clients on M&A transactions, commercial contracts, real estate matters, financing transactions and corporate law. To schedule a free consultation with Jennifer, please call 602-617-3938, or email us through our Contact Form.
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