- Choosing a business structure
is an important first step when starting a business.
Each business structure has advantages and disadvantages.
So which business structure should you choose?
In this video, we will go over each
of the business structures and give you an approach
for how to decide on the business structure right for you.
Keep in mind this is not business advice,
but a means to help you explore
the different business structures
and help you decide which is right for you.
If you are still unsure what business structure to choose,
consult with an accountant.
The first thing we need to talk about
are informal versus formal business structures.
Informal business structures
are sole proprietorships and general partnerships.
Informal business structures are simple to form
and thus are a great way
for testing a business in a low-risk environment.
They allow you to see if a business will be successful
before committing too much time and effort
in creating a formal business structure.
Informal business structures are also great
if most of your starting clients
are people you are familiar with.
However, informal business structures
do not have asset protection.
What this means is that,
if someone sues you or you default on a business loan,
your house, your car or your personal savings are at risk.
Asset protection is important when you are growing rapidly,
have customers you don't know personally,
when you are making a significant amount of money,
or your business is inherently risky.
Formal business structures provide credibility,
personal asset protection, and help build business credit.
So, if you are planning on having customers
you aren't familiar with, or rapid growth,
you'll probably want to choose an LLC or a corporation.
As mentioned before, one of the biggest benefits
to choosing a formal business structure
is the personal asset protection it provides.
In addition, formal business structures
also add credibility to your business
that informal business structures don't provide.
Your two options for formal business structures
are corporations and LLCs.
Corporations tend to be more complex business structures
and generally speaking aren't what you want
as a starting business structure.
Corporations also have double taxation,
which means that your profits are taxed twice.
Corporations are great if you are looking
to raise money from venture capital
or looking to list on the stock exchange.
Corporations are also able
to more efficiently carry money over
between tax years to reinvest into the company.
If you need money from professional investors
or are looking to carry money over more efficiently
between tax years, a corporation is the better choice.
LLCs are a much simpler business structure,
have a lot less paperwork,
and are easier to start and maintain.
They have pass-through taxation, which means your profits
are only taxed once, and they have all the benefits
of a formal business structure,
including personal asset protection
and increased credibility as a business.
In general, it's more beneficial to start as an LLC
when starting a small business
due to the simplicity and the pass-through taxation.
You could always change your business structure
and tax classification at a later date.
If you have decided that you need asset protection,
and that the simplicity and flexibility
of a limited liability company suits your needs,
that might be all you need to do.
You will have a strong, formal business structure in place,
registered with your state and the federal government,
and you'll be free to go on and make a profit.
A business structure is different
than a tax classification, however,
and an LLC has three options for how it can be taxed.
As your LLC grows and makes more profit,
you may decide to use a different tax strategy
to save money and reinvest profits.
As we discussed before, the default tax status
for an LLC is pass-through.
For a single member LLC,
the LLC is treated as a disregarded entity,
and the tax is passed through to the member.
If there are multiple members,
the LLC is taxed as a partnership.
Pass-through taxation means all distributions,
which is what payments to LLC members are called,
are subject to employment taxes.
An LLC which elects to be taxed as an S-Corp
allows members to become employees of the LLC,
so they can be paid a salary as well as a distribution.
Both of these are taxed differently.
It's a more complicated process
that requires additional professional accounting services
and is typically more closely scrutinized by the IRS.
So it is only recommended if you know ahead of time
that you will be making a certain profit
and can manage the administrative needs.
You can watch our video on the topic for more details.
An LLC can also opt to be taxed as a C-Corp,
which is the default tax status of a corporation.
But the same general restrictions apply.
You should really only consider it
when you know you will be making a large amount of money
which you want to reinvest back into the company
in different tax years.
At which point you should talk with a licensed accountant.
You have many choices when forming a business in America.
If you are just getting started and don't have anything
at stake, an informal business structure,
like a sole proprietorship or partnership,
may be sufficient.
If you are doing business in volume
or with anything at risk,
you'll want the asset protection that is provided
by a formal structure, namely an LLC or a corporation.
Unless you are willing to deal
with more complicated administration and taxes,
or are looking to reinvest money
in your company or take in investors,
an LLC is usually the best choice for small businesses.
If you know you are going to make a surplus of money
and want to save on employment taxes,
an S-Corp tax classification might interest you, as well.
We have, for more information, as well as tools and guides
for the business formation process for each state,
at our website HowToStartAnLLC.com.
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to deliver useful content to entrepreneurs.
I'm Tony with The Really Useful Information Company,
wishing you good luck for your small business.
(pleasant music)