On the winding road of entrepreneurship, you may not be thinking about the structure of your business as it relates to tax liability. Innovation, disruption, and making continual progress is instead most likely at the forefront of your mind. However, as you revisit or fill out your business plan or business model canvas for the first time, remember that what you decide upon as a business structure now can have far and wide reaching effects on your startup as it progresses. We have prepared an introductory guide to the different forms of business available so you can determine which one may be the best fit. Getting familiar with these structures early on can save you headaches later, so do yourself a favor and take a walk down business structure boulevard.
If you are flying solo, a sole proprietorship may be an attractive option as it allows you advantages such as claiming expenses and income from the business on your personal tax return. However, you may need to make estimated tax payments on a quarterly basis and also be willing to put your personal assets at risk in the event debts on the business need to be satisfied. Having complete autonomy may be less expensive to set-up initially, but there are also opportunity costs such as difficulty raising money or getting loans under this structure to consider.
The one agreement to rule them all. A general partnership involves active participants of two or more persons where each partner makes decisions for the business and assumes liability in tandem with each other. Costs to establish a general partnership will be more than a sole proprietorship, but partners will still be personally liable for debts owed by the business. The partnership does not pay taxes, and instead, income and losses pass through to each partner and appear on a separate tax document from the standard 1040.
A variation of partnership also comes by way of a mix of general partners and limited partners whose losses are limited to the amount of their investment and do not participate in the day-to-day operations of the business. This structure may be attractive if you are looking for passive investors to raise capital and maintain some autonomy in the decision making alongside other general partners. A variation of limited partnership is also known as a limited liability limited partnership which may include protections for general partners. Costs are also greater to establish this structure due to the need for legal and accounting services to set things up.
Limited Liability Partnership (LLP)
As the name suggests, general partners under this structure do not face the same kind of open-ended liability found in the first two partnerships described so far. This option may be a safer choice for everyone involved in your startup as what your liability does not extend to the resultant actions or outcomes of other partners. If you have a diverse mix of people in your organization making decisions, this provides some protections for your company if something unexpected occurs with a general partner while running the business. Medical practices, law firms, and accountancies commonly use this structure.
As a separate, legal entity apart from its owners, a corporation provides certain advantages such as liability protections, the ability to raise money, and the flexibility to change ownership more fluidly. However, incorporating involves a significantly higher cost due to the complex tax and accounting preparation in addition to legal guidance required. Double taxation is also a possibility as corporations are subject to tax in addition to the income earned and passed on to shareholders being taxed at their individual rates. The additional perks of a corporation come at a price, but incorporating, in the beginning, can also be a boon for your startup since your business structure will be able to adapt as it moves through various stages of funding and provide investors with protections not available under a partnership.
Non-profits may engage in private sector activities or pursue a mission to serve the public and its intended demographic. Commonly structured as a 501(c)3, nonprofits may need to register with state and federal authorities depending on the charitable activities they are participating in. Accounting is a major pillar for non-profits as donors and tax authorities require accurate reports on spending by the organization.
Limited Liability Company (LLC)
An LLC provides a mix of benefits such as the liability protection of a corporation and the single taxation structure of a partnership. All LLCs require articles of incorporation and may also require an operating agreement. Costs to establish this structure can be high as it will need experienced accounting and legal professionals for the set-up. A significant advantage of an LLC over a corporation is the flexibility in management structure and also that there is no limit to how many members or owners can be added in contrast to an S-Corp which caps at one hundred.