Organizing Your Business Structure
by dM

The demands of owning and managing a small business are so significant that it is tempting to neglect creating a formal business structure until something forces your hand. Frankly, this is how the vast majority of small businesses begin, yet eventually all business owners must somehow formalize their business structure in order to operate professionally and in an organized fashion when it comes to finance and accounting issues. If you cannot form a business entity immediately at the start of your business, either because of lack of resources to pay the various state and county filing fees or simply because you don’t have time, don’t put it off for too long or it could result in problems down the road. Add the formation of a business structure to your list of goals and establish a deadline for getting it done.

Some of the more important considerations in determining what type of entity you should form are:

• How much exposure you have to potential liability. Some business structures are designed to insulate your personal assets in the event of a judgment against you, such as in a products liability or personal injury case.

• Set up fees. Depending on which business structure you choose, the costs to form and maintain it may be significant. For example, it costs considerably more to form and maintain a subchapter S corporation than it does a sole proprietorship.

• Tax considerations. All business structures have some tax benefits. Some have more than others and you will want to consider all of them before choosing the right one for you.

Each state has its own requirements for the proper establishment of a business structure. Once a business is established in a state, it may be necessary to file a statement with the Internal Revenue Service so it knows how to treat the business for tax purposes. Most states and the IRS have extensive online informational websites and many also contain the forms you need to complete to set up a business. Any search engine should return your state's business website on the first page if you enter, "Start a business in 'my state,'" where you substitute your state for "my state." All states have business statutes and they should be consulted before a decision is made. The information provided here is not legal advice, but an overview for general guidance purposes. Contact an attorney in your state if you need legal advice.

The 4 basic business structures are:

• Sole proprietorship. This is the simplest and easiest structure for one person to maintain. The owner of a sole proprietorship is in complete control of the business, does not answer to any partners or investors and is solely responsible for the gains and losses of the business for tax purposes. Filing fees are inexpensive and the set up requires minimal paperwork. Taxes are generally lower for sole proprietorships than for other entities. A drawback is that if you become incapacitated or die, the business simply ceases to exist and the assets and liabilities become a part of your personal estate.

• Partnership. A partnership is a business entity that is owned by two or more persons (these persons can sometimes be other business entities such as other corporations) whose business relationship is governed by a partnership agreement. Each partner is personally liable for the debts and liabilities of the business to the extent stated upon in the partnership agreement. Partnerships may be attractive to people who don’t want to “go it alone” in business, but who also want to enjoy the relatively low start up costs associated with a partnership. There are typically low filing and maintenance fees and since each partner is personally taxed on business income, there are fewer tax related filings than with a corporation. You can avoid the problem of the business ceasing to exist if a partner dies by having a partnership agreement that specifically states what happens in the event of a death or incapacity.

• Limited Liability Company (LLC). LLC is a hybrid of a corporation and a sole proprietorship and is fast becoming the business entity of choice for small business around the country. Today, a handful of states still do not recognize LLCs so you will want to check with your state to make sure that LLC is an option for you. As their name implies, LLCs offer limited liability to their owners. But unlike corporations which also offer this benefit, LLCs are attractive because they require minimal start up and maintenance costs and provide a business with a great deal of organizational and management flexibility. The profits and losses of an LLC flow directly to its members for tax purposes.

• Corporation. The two major benefits of operating a business as a corporation are limited liability and the ability to issue stock in exchange for cash that may be needed to operate and expand the business. Maintaining corporate structure requires understanding that the law views a corporation as an individual much like a human being, endowed with certain rights and responsibilities. When describing corporations, courts often use terms like “artificial being” to describe a corporation. Corporations should thus be thought of as separate, distinct and individual and independent structures that are viewed by the law, as well as creditor sand debtors as totally separate and distinct from its individual owners.
  
  Incorporation requires the completion of significantly more paperwork and formality than other structures. In most states, if these formalities are not followed precisely, the corporate form can be ignored in the event of a lawsuit and individual owners can be held personally responsible for liabilities and contractual debts. A corporation is formed at the state level, and once the Articles of Incorporation are filed and accepted by the state, IRS approval is required to categorize the corporation as either a Subchapter S Corporation or a Subchapter C Corporation for tax purposes.

The IRS describes each business structure fully at its website at this link.

Indeed, it can be a daunting task to select a business structure along with all the other things a business owner needs to do just to get their products and services out there. On the other hand, boning up on the options and making the best selection for you provides as soon as possible offers a great deal of peace of mind, particularly in terms of insulating personal assets and ensuring the continuity of the business in the event of an emergency if an entity other than a sole proprietorship is chosen.

Finally, small business owners on limited budgets often ask me whether they should hire an attorney or an accountant if they cannot afford to hire both. That's a tough question and the answer will vary for each business, and it may even change for a single business from time to time depending on the circumstances. I usually answer this way. It's an over-generalization, but it makes a point. Lawyers can help you make money. Accountants can help you keep more of the money you make. You can make your choice based on that, and good luck!

The information provided here is informational only and provides basic and easy to understand primer on business structures and insurance related issues. It is not intended to be legal advice. To obtain legal advice specific to your circumstances, please consult an attorney or CPA in your area who is familiar with federal and local tax and business laws.