Choose A Type Of Business Structure For Your Small Business – Part One

As you’re planning and starting your new business one of the first things to decide is what legal structure or ‘entity’ you’re going to create.  There are many to choose from, starting with the very simple that afford little to no legal protection, to the very complicated.  A corporate structure (C, S or LLc) will provide you with much needed legal protection but they can be very complicated and expensive.  We will identify the major legal entities and some pros/cons for each.  For a more comprehensive and detailed breakdown of legal entities listen to our interview with Laura Wilcox.This blog post is considered informational only and requirements vary by state; please check with your local attorney to determine the specific requirements of your state.

Many businesses start by just ‘hanging out their shingle’, so to speak, and start!  Doing work on the side or selling products out of their home office.  It’s simple, cheap and requires no real legal effort.  This is fine for those that are doing business on the side, but not making very much money.  In these instances your liability exposure will be low.  This of course, depends entirely on what type of service you are providing.  Some business types have too much exposure to be operating without the protection of corporate structure.  A good example of this would be an accountant.

Speaking of accountants, no matter what you’re selling or providing you still need to claim the income on your personal tax return to avoid problems with the IRS.  Make no mistake; you want to avoid problems with the IRS.

The drawbacks to having no legal entity will begin as your business gets larger.  The liabilities you assume along with their risk will make not having a corporation very risky.  Just doing business as yourself puts all the legal risks on you personally.  If somebody sues you for something you did wrong, you could lose everything.  The fact they’re suing you personally means your house, car, everything, could be in jeopardy.  Someone could sue you for something you didn’t even do; this is where the legal entity becomes absolutely necessary.  It provides you protection from no fault legal issues that could otherwise ruin your life.

A DBA is only a very small step above a sole proprietorship.  A DBA just means that you are ‘Doing Business As’ a certain name.  For example, if your name is Robert Johnson and you’re a plumber you could file a DBA with your state calling your business ‘Johnson’s Plumbing’.  It’s a way for the state to record who is selling the product or service to the public.  The state wants the public to have the ability to look up who Johnson’s Plumbing really is if desired.  Unfortunately, a DBA provides you with no legal business protection whatsoever.  People can still file suit against you personally with a DBA.

A partnership is similar to a DBA in that it provides no legal protection to the partners.  It is merely an agreement between two entities.  Two people can agree to be partners or two companies can be partners.  The two parties will agree on the rules of engagement for the business they are conducting.  Nothing is required to be filed with the state (for the most part) and the IRS does not get involved.  The ‘rules’ of the partnership are called the ‘Partnership Agreement’.  The more complicated the agreement the more necessary it is that a legal professional is consulted.  As with any legal filings it’s always a good idea to have the documents reviewed by an attorney.  Just like a DBA and Sole Proprietorship you are responsible for personally paying the income taxes in a partnership.  The share of the profits used to calculate the tax will depend on the terms of your partnership agreement.

See Part Two for descriptions of  the three major legal entities.  They are the C-corporation, S-corporation and LLC or Limited Liability Company.