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Which Legal Form Is Best for Your Business?
When you start a business, you must decide on a legal structure for it. Usually you'll choose either a sole proprietorship, a partnership, a limited liability company (LLC) or a corporation. There's no right or wrong choice that fits everyone. Your job is to understand how each legal structure works and then pick the one that best meets your needs. The best choice isn't always obvious-after reading this chapter, you may decide to seek some guidance from a lawyer or an accountant.
For many small businesses, the best initial choice is either a sole proprietorship or-if more than one owner is involved-a partnership. Either of these structures makes especially good sense in a business where personal liability isn't a big worry-for example, a small service business in which you are unlikely to be sued and for which you won't be borrowing much money. Sole proprietorships and partnerships are relatively simple and inexpensive to establish and maintain.
Forming an LLC or a corporation is more complicated and costly, but it's worth it for some small businesses. The main feature of LLCs and corporations that attracts small businesses is the limit they provide on their owners' personal liability for business debts and court judgments against the business. Another factor might be income taxes: You can set up an LLC or a corporation in a way that lets you enjoy more favorable tax rates. In certain circumstances, your business may be able to stash away earnings at a relatively low tax rate. In addition, an LLC or corporation may be able to provide a range of fringe benefits to employees (including the owners) and deduct the cost as a business expense.
Given the choice between creating an LLC or a corporation, many small business owners will generally be better off going the LLC route. For one thing, if your business will have several owners, the LLC can be more flexible than a corporation in the way you can parcel out profits and management duties. Also, setting up and maintaining an LLC can be a bit less complicated and expensive than a corporation. But there may be times a corporation will be more beneficial. For example, because a corporation-unlike other types of business entities-issues stock certificates to its owners, a corporation can be an ideal vehicle if you want to bring in outside investors or reward loyal employees with stock options.
Keep in mind that your initial choice of a business form doesn't have to be permanent. You can start out as sole proprietorship or partnership and, later, if your business grows or the risks of personal liability increase, you can convert your business to an LLC or a corporation.
For some small business owners, a less common type of business structure may be appropriate. While most small businesses will find at least one good choice among the four basic business formats described above, a handful will have special situations in which a different format is required or at least is desirable. For example, a pair of dentists looking to limit their personal liability may need to set up a professional corporation or a professional limited liability company (PLLC). A group of real estate investors may find that a limited partnership is the best vehicle for them. These and other special types of business organizations are summarized in Section F at the end of this chapter.
You may need professional advice in choosing the best entity for your business. This chapter gives you a great deal of information to assist you in deciding how to best organize your business. Obviously, however, it's impossible to cover every nuance of tax and business law that applies to your business. This is especially so if your business has several owners with different and complex tax situations. And keep in mind that especially for businesses owned by several people who have different personal tax situations, sorting out the effects of "pass-through" taxation (where partners and most LLC members are taxed on their personal tax returns for their share of business profits and losses) is no picnic, even for seasoned tax pros. The bottom line is that unless your business will start small and have a very simple ownership structure, before you make your final decision on a business entity, you'll want to check with a tax advisor after learning about the basic attributes of each type of business structure from this chapter and Chapters 2, 3 and 4.
