One of the most frequently asked questions when planning a new small business start-up is, “What’s the best legal structure for my business?” This is also one of the most important to answer because the structure you choose will affect everything from paying taxes to assigning liability, from raising capital to sharing profits.
Each type of structure has trade-offs that should be fully understood. Here’s a quick comparison as provided by Central Maine SCORE mentor Maurice Ouellette.
“The most common,” Ouellette said, “is a sole proprietorship, which is an unincorporated business owned by one person. Here, paying taxes is relatively simple, as the owner reports income/losses along with his own personal taxes. However, the owner is personally responsible for any business-related expenses or liabilities.”
In a partnership, two or more people share ownership. Each contributes time, resources, expertise and/or money to the business in return for a share of the profits/losses. Each partner is also responsible for their own actions, as well as business debts and decisions made by other partners. That is why a partnership agreement is a must, detailing each participant’s contributions and responsibilities, division of profits, resolution of disputes and the handling of other major business decisions.
Then there is the corporation, an independent legal entity owned by shareholders. These inherently have complex administrative, tax and legal requirements. A plus is that shareholders are not legally liable for the business’s actions and debts.
A variation of this structure is the “S corporation,” named for the IRS subchapter that defines it, often used in situations in which the shareholders are also employees. As Ouellette points out, “S corporations carry the same legal and administrative requirements of regular corporations, but treat wages and profit distributions at different rates.”
A popular structure for small businesses is the limited liability company (LLC). This variation offers the limited liability of a corporation and the flexibility and simplified taxation of a partnership. There are also fewer record-keeping requirements, and it’s entirely up to the LLC’s owners to determine profit distribution. However, LLC members must pay self-employment taxes and make their own Medicare and Social Security contributions. And when an owner (member) leaves, the LLC must be dissolved.
Each structure has provisions and options that should be explored before the decision for your small business is reached. SCORE offers help with this and any other small business issue by providing training resources and a network of more than 13,000 volunteers who provide free counseling.
For more help, contact Central Maine SCORE at 782-3708, at email@example.com, or contact the Auburn Public Library for an appointment with a volunteer mentor. In Oxford Hills, call 743-0499; in Rumford-Mexico, call 364-3123. Or contact SCORE at www.SCOREmaine.org.
This column is provided by the Central Maine SCORE chapter.