9/26/2006
Legal Structure: Factors Affecting Choice
by Phil Harris, Business Consultant, UALR Lead Center
Deciding on a legal form of business is one of the most important decisions a new business owner will make. Which of the legal structures is right depends on the type of business you plan to run, how many owners it has and its financial situation. Our discussion with any existing or perspective business owner would center on several of the most important factors to consider, which are:
1. Risks and Liabilities - the potential risks and liabilities of the business. In large part, the best ownership structure for their business depends on the type of services or products it will provide. If the business will engage in risky activities they will almost surely want to form a business entity that provides personal liability protection ("limited liability"), which shields your personal assets from business debts and claims. A corporation or a limited liability company (LLC) is probably the best choice for you.
2. Formalities and Expenses - Sole proprietorships and partnerships are easy to set up--you don't have to file any special forms or pay any fees to start the business. Plus, you don't have to follow any special operating rules. LLCs and corporations, on the other hand, are almost always more expensive to create and more difficult to maintain.
3. Income Taxes - Owners of sole proprietorships, partnerships and LLCs all pay taxes on business profits in the same way. These three business types are “pass-through" tax entities, which means that all of the profits and losses pass through the business to the owners, who report their share of the profits (or deduct their share of the losses) on their personal income tax returns. Therefore, sole proprietors, partners and LLC owners can count on about the same amount of tax complexity, paperwork and costs. Owners of these unincorporated businesses must pay income taxes on all net profits of the business, regardless of how much they actually take out of the business each year. In contrast, the owners of a corporation do not report their shares of corporate profits on their personal tax returns. The owners pay taxes only on profits they actually receive in the form of salaries, bonuses and dividends. This separate level of taxation adds a layer of complexity to filing and paying taxes, but it can be a benefit to some businesses.
4. Investment Needs - Unlike other business forms, the corporate structure allows a business to sell ownership shares in the company through its stock offerings. This makes it easier to attract investment capital and to hire and retain key employees by issuing employee stock options.
You can learn more about choosing the appropriate legal structure by taking the ASBDC SmallBizU on-line training class “Choosing a Legal Structure” and check out the free documents at asbdc.ualr.edu/bizfacts. The ASBDC always recommends the use of an attorney and accountant during the decision of choosing a legal structure.
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