Forming a legal structure for your startup is vital to protect your personal assets from debts and other business liabilities. It’s a process that doesn’t take too much time at all since it usually takes only 10 days in most states and three to four weeks in some states, according to a report on LegalNature. A business structure or entity affects your company’s daily operations, fundraising abilities, management, amount of liability during lawsuits, and determines your tax rates.
So, if you have been thinking about starting a business, it’s important to choose a legal structure that gives you the right balance of legal benefits and protection. You can choose to form a sole proprietorship, an S or C corporation, general partnership, limited liability partnership, or limited liability company. The type of entity you settle for will depend on various factors. Below are a few considerations when choosing the right legal formation for your new business.
Type of Legal Structure
Understanding the unique aspects of different business legal structures is the first step to making informed decisions. When you opt for sole proprietorship, for example, you don’t need approval to set up your business. And while the formation process is simple, you risk losing personal assets if your company faces lawsuits. To separate your assets from the business, you may opt for a limited liability company (LLC), partnerships, or corporations.
Typically, a partnership allows two or more individuals to own a business. It’s worth noting you and your business partners can form a general partnership or limited liability partnership. A general partnership ensures all members share responsibilities and profits equally, while a limited liability partnership gives one member control of operations and the other partners contribute to the business and receive profits.
A corporation, on the other hand, gives you legal separation from personal assets and business liabilities. This structure functions as a separate legal entity, with its own name and company seal, meaning you can borrow money and own properties through the company. Plus, shareholders in the company aren’t liable for the business’s liabilities. If you’re looking to enjoy the benefits of partnerships and corporations, without a heavy tax burden, a limited liability company is the best option. Like a corporation or company, an LLC limits your liabilities while you enjoy the tax flexibilities of a partnership.
Ease of Formation
Sole proprietorship is the easiest entity to set up, as it requires you to register your business with the relevant agency in your state. Partnerships are other easy to form legal entities because they require little paperwork. You’ll need to draft Articles of Partnership agreement, file for a Certificate of Conducting business as partners, and apply for a business license. While there are fees associated with this process, it’s cost effective.
Forming a corporation or company is complex compared to sole proprietorship and partnerships. To form a corporation, you need to choose a business name, file articles of incorporation, appoint a board of directors, and prepare for taxation and regulatory compliance. If you choose to form an LLC, choose a name for your business and designate a registered agent to receive all legal or official documents.
A registered agent should be 18 years and above, has an address in the state you’re registering your business, and is available during work hours. However, it’s wise to hire a company that offers registered agent services. Considering there are many registered agent services available, it’s vital to read customer reviews to identify the best. Reading LegalZoom LLC reviews, for instance, gives you an idea of what to expect when forming an LLC for your business. You’ll get insights about formation prices, packages, legal protection plan, and customer support the agent offers.
Think About Taxation
Before making any decision, it’s crucial to evaluate the tax ramifications of each business entity. For example, if you choose to incorporate your business as a C corporation, you become subject to double taxation. This means your company pays taxes to the state and federal government. It’s also mandatory that you pay taxes on the personal income you earn from the company.
To avoid double taxation, consider forming a limited liability company (LLC) or an S corporation. These business structures give entrepreneurs the privilege of enjoying pass-through taxation. Instead of imposing taxes on the corporation and the owner’s income, LLCs and S corporations allow the tax to be subject to the income the business owners and investors receive from the company.
However, there’s a disadvantage linked to S corporations. As an S corp owner, you’ll be paying self-employment taxes for the amount you earn from the company. For LLC owners who enjoy tax treatment like sole proprietors and partnerships, the government expects them to pay self-employment taxes. This tax is imposed on the profits they take home.
Forming a legal entity for your business is an important step to protect personal assets from business liabilities and debts. Given there are different legal structures, you need to review each option carefully and pick one that provides the right balance of legal protection and tax benefits. With this understanding, you need to factor the ease of formation, tax implications, and transfer of ownership before settling for sole proprietorship, LLC, partnership, and corporation.