Which Business Structure Should You Choose?

November 5, 2007

If you are considering starting your own small business, you’ll need to consider the way you will structure your business. There are four main types of business structures, sole proprietor, partnership, corporation, or limited liability corporation.  How do you know which one to choose?

Most people who are starting a small business tend to start as either a sole proprietor- if they’re going at it alone - or as a partnership if they’ve gone one or more people who are working alongside them in the business.  The reason most businesses start out this way is not because it’s the “right” way; but because it’s the simplest way to start out!  You can operate legally as a business in most states just by using your legal name; and it prevents the need for paperwork and expensive business structuring.

There is actually no right or wrong answer; but some business structures just may make more sense than others for what you plan to do with your business, the size of your business, and how the advantages and disadvantages of each business type affects you as the business owner.

The most obvious distinction between the four different types of business structures is how they are taxed.   You may have heard that incorporating your business saves you self employment tax.  If you’ve talked to any of your knowledgeable friends or family about your intent to start a business, I’m willing to guess at least one of them has said you’ll pay an arm and a leg in self employment tax as a sole proprietor.  What they maybe didn’t explain is that while you only pay half the taxes out of your personal income if you are an incorporated business; the other half is paid out of the corporation- and so you end up paying the exact same amount.

The distinction is this, really.  As a sole proprietor or partnership business, all business income is treated as your personal income.  When you have a corporation or limited liability corporation, you can keep some of the income in the business as retained income, so you aren’t making as much “on the books”, and you aren’t paying personal income tax on any income that’s retained by the business.

Whichever business structure you choose, it’s always good to talk with an accountant before making your final decision.  Not only can they give you the ins and outs of each business structure, but if they have access to your current financials for the business, they can help you decide which structure makes the most sense from a financial standpoint as well.

Posted in Starting a Small Business