How Could Choosing the Right Business Structure Save You Money?
Choosing an enterprise’s structure is an important consideration for anyone starting their own business. Which format is most appropriate for a particular venture depends on a combination of factors, particularly the business owner’s tolerance for taking personal risks. Here, we look at the most common business structures, identifying the main benefits and drawbacks of each and highlighting advantages from a tax-saving perspective.
The choice of business structure has critical tax implications
Business structure also determines whether the business owner’s personal property is vulnerable in the event of a legal claim against the business. Anyone who operates a commercial enterprise faces an increased risk of having a lawsuit filed against them or their organization. Businesses interact with the world, including other businesses, suppliers, employees, clients, governmental entities, and the public at large. Many of these interactions involve money changing hands.
With some business formats, the venture becomes a corporate entity in its own right. It is responsible for settling its own debts, including tax liabilities. Similarly, business assets vest in the name of the business.
With certain other structures, however, the business is treated as a “pass-through” entity, with profits passing through to the individual business owners. As well as benefiting from income, the business owners are also responsible for meeting any liabilities. In the event of a lawsuit being filed against the business, the owners’ personal assets would be vulnerable.
The different types of business structures
Sole proprietorships — The simplest business format to set up and operate, sole proprietorships are the most prevalent type of business structure in the US today. A sole proprietorship is treated as a pass-through entity in law. As well as benefiting from business income and assets, business owners are also personally liable for all business debts and losses. No taxes are incurred in the name of the business, but rather the business owners are responsible for reporting the profits in their own tax returns.
Partnerships — In law, a business partnership consists of two or more partners carrying on in business together. They agree to share all business profits and losses. Again, partnerships are pass-through entities, with the owners benefiting from all profits as well as being held personally responsible for all business debts, including taxes.
Limited Liability Companies — With this corporate structure, profits and losses pass through to the business owners without the business itself being taxed. The advantage of this hybrid form of partnership is that it shields business owners’ personal assets from legal claims.
S Corporations — A company with 100 or fewer shareholders can be registered as an S corporation, provided that no shareholder is either another for-profit business or an individual who does not have a green card who fails to meet IRS residency requirements. With S corporations, shareholders have only limited liability. Profits are taxed on shareholders’ individual returns rather than the business itself being liable.
C Corporations — With this business structure, profit generated by the business is taxed at a corporate level. Individual shareholders must also pay income tax on distributions, culminating in double taxation. Although C corporations can be disadvantageous from a tax perspective, they do offer shareholders protection from legal claims and business debts.
Many businesses change structure later on
Over the lifetime of an enterprise, its operations, scope, and scale can change considerably. Choosing the right structure for a business does not simply depend on where it is now but on the founders’ ambitions for the future of their company.
Further, not only does corporate structure dictate whether the business owners’ personal property will be protected from business creditors, but it could significantly impact the amount of tax paid on profits as well as affect the business’s ability to raise funding and the amount of paperwork it will be required to do.
Which business structure is best?
Vice president and co-owner of EnviroTech Coating Systems Mark Kalish has been involved in setting up several startups, both as a business owner and in various management positions. He indicates that in trying to decipher the optimum business structure for a particular company he looks at a variety of different factors, with a great deal depending on the individual circumstances of each business owner. Kalish points out that each situation he has been involved in was different. With so many variables to take into account, it is impossible to generalize and conclude that one business structure is better or worse than another.
Kalish cautions that choosing which business structure to adopt is not a decision to be entered into lightly. He urges business owners to seek expert advice when considering the various business structures and their pros and cons, as some have come to regret not taking the time and spending the money on getting professional advice upfront.
Guidance can be sought from a variety of sources, ranging from free or low-cost advice from small business groups to personal lawyers or accountants.