Do you know the best legal structure for your small business? Legal structure refers to the way a business is organized. Choosing the best legal structure for your business is critical, as it affects aspects of your business ranging from tax payments to your personal financial liability. The most common types of business legal structure are sole proprietorships, partnerships, and corporations.
The most common and simplest legal structure is a sole proprietorship, or a business owned by one person. The owner and the business are the same entity in terms of taxation: the business profits are personal profits and taxed as personal income. The owner is financially responsible for business and their personal assets will be used to cover losses or debts incurred by the business.
Two or more owners of the same business may file for partnership status. This type of business structure is very similar to the sole proprietorship- all partners are held financially responsible for the debts of the business and the tax burden is borne proportionally by the partners.
The most complex business structure, and the most difficult to obtain, is the corporation. In a corporation, the owners and investors are separate from the business in terms of taxation and income and are not held entirely liable for the company’s debt.
S-Corporations (Single Person Corporation) are an option for one business owner who wants to create a corporation to save money on taxes. As the sole employee of the business, they receive a salary out of the business profit and pay the appropriate income tax. The rest of the business profit they receive as a dividend payment, on which much less tax is paid. Therefore, by separating the profit into salary and dividend, the S-Corporation owner saves money on taxes.
When deciding on the best business structure for your business, consider that most businesses start small, beginning as a sole proprietorships or partnerships. These business structures require minimal paperwork and have a simple filing process, and are best suited for smaller businesses where there is less chance for high losses or being sued. Once your business takes on more risk, deals with higher amounts of debt, or requires substantially more capital, you should consider filing for corporation status to safeguard your personal assets and have access to more capital.