Comparing Business Organization Types: Which is Right for Your Small Business?
If you’re a small business owner starting out, it may seem overwhelming to decide how you should set up your business. There is no one option that suits every person’s situation and company. Understanding the pros and cons of the most common business organization types can help you narrow your options. Also, consider retaining a Washington DC small business attorney who can provide additional information and help you through the set-up process.
Many single owner small business owners set up as a sole proprietorship. It’s the easiest and most inexpensive option, which is why it’s popular. Sole proprietorships don’t have to adhere to as many formalities as a corporation or even LLC.
One of the biggest downsides to a sole proprietorship is the potential liability exposure. Your business is seen as an extension of you, which means your personal assets can be at risk for being attached to cover company debts, liabilities, and obligations.
For taxation purposes, sole proprietorship owners pay their income taxes for the business along with their personal returns; there is no separate filing.
To form a partnership, there must be more than one business owner. Much like a sole proprietorship, partnerships are easy to set up and have minimal upfront costs. It is not a separate legal entity, and faces some of the same issues as a sole proprietorship. Partners pay taxes on their own individual returns, although the partnership still files a return, which is more informational in nature.
Owners are called partners and they are not protected from personal liability or debts of the business. There are some variations of partnerships available in some states that may offer limited liability protection.
Limited Liability Company (LLC)
LLCs are formed under state laws and are one of the newer types of business structure. An LLC is desirable because it combines the liability protection of a corporation and the tax benefits of a partnership or sole proprietorship. The IRS does not recognize an LLC as a separate legal entity, which means the LLC decides how it wants to be taxed. You can opt for sole proprietorship (mandatory if you only have one owner), partnership, or corporation. It’s an example of what is known as a “pass-through” entity.
LLCs are required to use either Limited Liability Company or LLC in their name. Owners are called members and an LLC must either be member-managed, which means everyone has the same right to participate in day-to-day management, or manager-managed, where one or more people are appointed. Partnerships create partnership agreements while LLCs have operating agreements. These are important as they can help avoid member disputes down the line.
C corporations are traditional corporations and what most people think of when they hear “incorporated.” They provide personal liability protection, but they also cost the most to setup and maintain. Owners are called shareholders and own stock in the corporation. There are specific requirements that must be met, including designation of officers, annual meetings, and strict record keeping.
There is also an issue with double taxation as the corporation is taxed on its income and then shareholders are taxed on dividends. There is a newer IRS designation called the S corporation that alleviates the double taxation issue, but the requirements are very strict. For example, all shareholders must be domestic individuals, you cannot have more than 100 shareholders, and you can only issue one class of stock.
Retaining a Small Business Lawyer
The attorneys at Tobin, O’Connor & Ewing in Washington DC have years of experience assisting small business owners with a variety of legal matters. Contact our office at 202.362.5900 to schedule a consultation and let us help with all your small business needs.