Business Structures
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Fundamental Business Structure Concerns
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There will be many concerns associated with the business structure you select. However, if we keep our view "above the trees" without getting into too much detail, there are essentially 3 main areas of concern in selecting a new business structure. The 3 main areas of concern in selecting any business structure include:
  1. Taxes,
  2. Liabilities, and
  3. Business Formalities
Let’s go into a little more detail on each of these 3 areas of concern.

1. Taxes

Many new business owners hate even hearing the word "taxes," but don’t let the word "taxes" intimate you. For starters, the reality is that businesses must pay taxes. The key is not to necessarily know everything about taxes. Rather, the key is to learn enough about taxes to spot issues that may affect your business. Then, hire an accountant and/or tax attorney to deal with the nitty-gritty details of tax law. If you know enough about taxes to spot major issues, you will stay ahead of your competition and help to save your business money (and maybe lots of money).

The business structure you create will alter how you pay your taxes. The Internal Revenue Service ("IRS") controls how businesses are taxes at the federal level, and your state and local governments control taxes at the state and local levels. New business owners always want to avoid any unnecessary taxes, i.e. taxes you can avoid. However, for most small business owners, setting up a business in a different state just to avoid a few bucks on taxes generally is not the best choice. But you’ll obviously want to consult an attorney for your particular situation.

With that said, there are 2 basic ways in which you can be taxed based on the selection of your business structure:
  1. personally, or
  2. as a corporation
Sole proprietorships and partnerships are generally taxed personally. That means that the profits made are taxed at the individual’s tax bracket rate, which usually varies around 15% to 35%. You can take a look at what you paid in taxes last year for a general idea about what you might expect to pay (while also taking into consideration what you expect your business to generate in profits).

Limited liability companies ("LLCs") can be taxed personally like a sole proprietorship or partnership, or elect to be taxed as a corporation. Corporations’ profits are taxed twice – (i) at the corporate tax rate and (ii) personally at the individual’s tax bracket for the profits received.

Now, this is just the bare, bare bones of taxes. But understand that sole proprietorships and partnerships are generally taxed at the personal level. LLCs can be taxed at the personal level or corporate level (i.e. taxed twice), and corporations are taxed twice at the corporate level and personal level.

2. Liabilities

The next main area of concern in selecting a business structure deals with liability. Liabilities are all the potential things that a business could "get in trouble for" or "be accountable for." Businesses can be liable for both acts, i.e. things done, and/or omissions, i.e. things that were not done. If you’re wondering how a business could be liable for an omission (something it did not do), consider a business owner that hires a minor worker, i.e. under age 18, without determining the youth’s age. You can probably imagine, that depending on the type of work and hours performed by the minor, that business owner could be liable for failing to check the minor’s age (this is an omission).

There are many, many types of liabilities that can arise with every business. With that said, the 2 fundamental ways in which liability is assessed include: (1) personal liability and (2) limited liability.

Personal liability means that you will be personally liable for the acts and/or omission of your business. For example, if you’re personally liable for your business and you take out a loan with a bank and fail to pay the bank, that bank may file a claim against not only all of your business assets (e.g. cash, materials, buildings, vehicles, accounts receivable – money that people owe you), but also all of your personal assets including your car, house, personal bank accounts, right down to the pennies in your piggy bank. It is generally best to try to avoid personal liability as much as possible.

Limited Liability means that you will generally only be liable for the amount of money you invested in the business. This means creditors and others (e.g. plaintiffs) generally can only go after your business assets. They generally cannot touch your personal assets, unless you act in a way that would allow the creditors or others to pierce the corporate veil, i.e. to pierce your limited liability (and get to your personal assets). Please read "Pierce the Corporate Veil, If You Dare" for further details on how this works.

3. Business Formalities

Business formalities generally refer to the amount of legal paperwork, filings, and other legal requirements that you must follow. The further you move down the business structure diagram [link] from sole proprietor to corporation the more business formalities you’ll generally have. Sole proprietorships don’t really have many business formalities, while corporations generally have their fair share of business formalities. The formalities involved with partnerships and LLCs will generally relate to how the business structure is set up.

Next, let’s take a brief look at the business structure of sole proprietorships.

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