One of the most crucial decisions you’ll have to make when setting up a new business is what structure to use. The choices range from a simple sole proprietorship to the C corporation structure used by Fortune 500 companies.
The form you select dictates crucial issues, such as legal liability, tax treatment and the kinds of shareholders you can have.
“It’s certainly as important as the nature of your business and the way that you operate,” says Eric Siegel, president of Siegel Management Co., a business consulting firm in Bryn Mawr, Penn. “It’s easy to do this fast and wrong.” He and others recommend you consult an attorney, an accountant or both.
“In working with those advisers, you need to know what your objectives are with the company, your plans for operations and perhaps more important your plans for capitalizing the company,” Siegel says. “It’s not one-size-fits-all, but it’s not brain surgery either.”
Here are some of your options along with experts’ views of them.
If you are working for yourself with no partners, this is the simplest structure. You are your own business. You simply report your income on Schedule C of your 1040 tax form. But in addition to your normal income tax, you pay a self-employment tax for Social Security and Medicare.
- Potential users: Freelance business consultants, freelance journalists.
- Advantages: Simplicity, savings on overhead expenses — only one tax return, one bank account.
- Disadvantages: Self-employment tax (15.3 percent), no limit on legal liability.
That tax totals 15.3 percent (twice the rate you’d pay if you were working for a company) of your business income after deductions. It only applies to your first $102,000 of adjusted income. You can deduct one-half of the self-employment tax money you owe from the total amount that’s subject to your normal income tax.
You are personally liable for all the debts of your business. “That can include everything from your electricity bills to someone coming into your store, falling and then suing,” says Richard Rampell, chief executive of Rampell & Rampell accounting firm in Palm Beach, Fla.
Someone providing a simple service from his/her home — a business consultant or a freelance writer for example — may select this structure. If you don’t expect lawsuits, remaining a sole proprietor saves you the legal and accounting expenses of a formal company.
Tony Decello, a financial adviser at Deloitte Tax in Cleveland, says many of his clients initially favor a corporate or limited liability company, or LLC, structure to shield themselves from liability. But doing so doesn’t make sense for an individual, “unless you’re making significant money to justify two sets of books and two bank accounts,” says Decello, who has represented top golfers and tennis players.
And even as part of a corporation or LLC, an employee is personally liable for his/her own actions. “People will sue the entity and you,” he points out. “It’s often cheaper just to buy commercial liability insurance.”
If you choose the sole proprietor option, you can still give your business a name other than your own to make it sound more professional. Simply register as a business with your municipality.
Brendan Murphy, a journalist and business consultant, named his business Curragh Publishing (borrowing the word for a small Irish boat) and opened a bank account using that name.