The type of business structure you choose should be dependent on a lot of factors, some of which may include:
Are you going to be the sole owner of your business? You won’t be able to start a partnership if you’re going it alone, but you can operate as a sole proprietorship or maybe even an LLC.
Sole proprietorships are the simplest way for a new small business owner to establish a business on their own. It’s also the most affordable way to begin a business. Technically you don’t really have to do anything. You can just start doing jobs for people and you’ll be considered a sole proprietor.
From a tax standpoint, there’s no distinction between an individual and their sole proprietorship business. The vast majority of businesses in the United States – nearly three quarters – are technically sole proprietors. As of the 2018 tax year – the most recent available year of tax data from the IRS – 27.1 million tax payers claimed sole proprietorship income.
There’s one big disadvantage with going the sole proprietorship route – a lack of personal protection. You and your business are technically the same thing, so your business’s financial losses are also your personal financial losses. If you need to file bankruptcy it would be a personal bankruptcy, not a commercial bankruptcy. If your actions as business open you up to liability and damages, you’ll be personally on the hook for those.
You’ll also need to pay all your self-employment taxes – Social Security and Medicare – as well as personal income tax for all your business income.
Even though you don’t necessarily need to register a sole proprietorship with the state or federal government, there may still be some bureaucratic hoops to jump through to make your business legal. Even sole proprietors might be subject to licensing and registration requirements of local municipal or city governments. You might also need to establish some method of collecting and paying state and municipal sales tax, depending on your business.
When you file your taxes, you would use a Schedule C form (Form 1040) to report income or losses for you and your business. You would also need to report and pay any employment taxes if your sole proprietorship employed anyone else during the fiscal year.
Sole proprietorships and partnerships aren’t all that dissimilar, except two owners are sharing the risk and profits. How formal or informal a partnership needs to be is often dependent on the partners, but you should ideally have a signed contract in case disputes arise.
Being able to share resources and assets is often a good thing, as is the ability to share losses should they occur. It’s not uncommon for disagreements to arise between partners on how to run a business, which is why having a solid partnership agreement is generally in the best interest of both owners.
There are several LLC pros and cons. Maybe the biggest motivating factor for businesses that form an LLC is the liability protection. LLCs essentially create a wall between your personal finances and your business finances, so if your business is liable for something you have some personal protection. There are even some estate planning benefits, like you can put your LLC membership in a living trust.
There’s also more flexibility for LLCs when it comes to taxes. The LLC can distribute profits to the owners and the owners’ income can be taxed like normal through personal income tax. Alternatively, LLCs can be taxed like corporations. You should speak with an accountant or business consultant to learn more about which method is best for your business.
There are some potential problems with LLCs. Depending on the states in which you do business LLCs with single owners might face some limits on the asset protection it provides. LLCs might also be subject to state-specific rules on transferring ownership, like requiring consent of each owner to modify membership in the LLC.
H&H Accounting Services is committed to providing exceptional bookkeeping, business tax preparation and consulting services for all types of businesses in Phoenix, including sole proprietors, partnerships and limited liability companies. If you have questions about which type of business structure is best for your industry, give us a call at (480) 561-5805.
We offer free one-hour consultations and would be happy to come to you to discuss your business’s needs.
