When you’re just starting a new small business it may be easiest to operate as a sole proprietorship. All you need for that is a business card. But if you need to hire employees, you need to raise money from investors, or you want to protect yourself from being personally liable for the business’s debts, you may want to set up a more formal business structure.
When you decide to move beyond a sole proprietorship, you will need legal advice. Your local chapter of SCORE, a nonprofit association dedicated to helping small businesses succeed, may be able to offer you some advice or connect you to a lawyer. The Small Business Administration also has some resources on its website.
Here are some of the most common business structures:
When you start working as a sole proprietor, the name of your business is automatically your name. If your name is Jane Smith, your business will be called ‘Jane Smith’ by default. If you’d like your business to be called ‘Jane Smith Designs’ or anything else, you will need to file a DBA, or a ‘doing business as’ name. You’ll also need a DBA if you’ve already set up an LLC or a corporation and you want to do business under a different name.
This should be a simple, straightforward process. You just file your new name with your county or state, depending on the regulations where you live. The SBA website can help you find the rules for your state.
An LLC is a limited liability company. It’s the simplest form of business you can set up. It’ll protect you from being personally liable for business debts—without a lot of paperwork—but you’ll still be taxed as a self-employed individual.
LLCs can be owned by a single person or two or more partners. To form one, you need to register with your state and, depending on your state, you may need to create an operating agreement that explains how your business is organized and how profits will be distributed among its members. Still, registering an LLC is much simpler than setting up a corporation, so the paperwork is relatively light.
As the name implies, an LLC will limit your personal liability for the business’s debts, as long as you are diligent about keeping business and personal activity separate. All the business’ profits and losses will pass through to your personal tax return (and the returns of your partners, if you have any). That means you’re not filing a corporate tax return on top of your personal return, but it also means that you’re considered self-employed for tax purposes, and you’ll be taxed on your business’ entire net income.
A corporation is a separate legal entity, owned by its shareholders. It protects you from personal liability. In order to set one up, you’ll need to file articles of incorporation and meet other administrative requirements. Creating a corporation allows you to raise money by selling stock, but because of the fees and paperwork involved, it probably won’t make sense to do this until your business starts growing significantly.
If your business is a corporation, it becomes a separate taxpaying entity. Typically, corporate tax rates are lower than income tax rates, but in some cases, corporate income may be taxed twice—once when the corporation pays its taxes and once when you as an individual collect the business profits in the form of dividends.
An S corporation, or S corp, is a specific type of corporation that eliminates the problem of double taxation. To set one up, you’ll first file as a corporation, and then complete anIRS form to designate that corporation as an S corp. You can also register an LLC as an S corp.
The key benefit of an S corp is that the corporation itself isn’t taxed. As the business owner, you’ll pay yourself a salary, and then you can take any remaining profits as distributions. This means you won’t pay self-employment tax. You can withhold taxes from your salary, and the tax on your distribution payments will be lower. But you’ll need to be careful how you organize these payments, because unusually low salaries and high distributions may trigger an audit. Your salary has to be in line with the standards for your industry.
Whatever business structure you choose, you will need a lawyer to help you set it up correctly. But there are a variety of ways you can wall off your personal assets from the success or failure of your business, minimize your tax burden, and build a business that’s prepared to grow over the long term.[image: Paperwork by Heather on flickr]