What if there was a way of doing business that would save the owner money and prevent trouble? Well, there is. However, it is not the same for every business.
To be clear, there is no one business entity choice that is perfect for every business venture. Choosing the right business structure can save you money and prevent headaches. There are several different legal structures that you can choose from to operate your business.
Based on your circumstances and your business plan, one entity may be more favorable than another. There are legal benefits, tax benefits and operational benefits to each entity.
You must choose a business entity or one will be chosen for you by default. Your business goals should help you determine your choice. Do you want to keep things simple and easy? Do you want to limit your liability? Do you want to save on taxes? Do you want to attract investors? All of these questions will impact your entity choice. Keep in mind that as your business changes, so can your choice of entity.
Let’s discuss some of the most common entities and why you might choose one over another. We’ll take a look at these different entities over the next few weeks.
Let’s start with the most common and most simple - Me, Myself and I…
The Sole Proprietorship
A sole proprietorship is normally the simplest and most common form of business. It is normally the least-regulated form of business and is easy to setup. In fact, if you don’t incorporate, have a partner or setup an LLC, the law will default you as a sole proprietor. You just have to obtain whatever business licenses and permits your locality requires and you can begin operations.
As a sole proprietorship is basically you doing business as yourself or under a registered business name (DBA – Doing Business As), sole proprietorships are quick and easy to setup and the fees to do so are the least expensive of the options to setup.
While you don’t go into business to lose money, you might as you get started or during a rough economic time period and as you report all the profits and the losses on your personal income tax return, any losses lower other income your household might have which creates tax savings. As it is just you, you have complete control over your business. When it is time to end the business, it is also easy to terminate.
There are downsides to being a sole proprietor. The largest of these is that you have unlimited personal liability for your business. You are personally responsible for all of your business debts and all of your personal assets, such as your home and vehicle can be grabbed by creditors to satisfy the debts. If your business fails, you are still personally liable for the business debts. You can minimize the risk of liability from personal or physical injury through proper insurance coverage.
Another downside relates limited tax savings for certain benefits. The IRS doesn’t allow you to deduct the costs of group life insurance, long-term disability insurance and medical cost reimbursements of sole proprietors that it allows other entities to deduct. In addition to paying income taxes on your profits you will also pay self-employment taxes (Social Security and Medicare) on your profits.
You cannot be an employee of your business because you are the business. You can’t pay yourself a salary and deduct it as a business expense. You can only withdraw money from the cash flow of your business while the amount of the your draw "stays" in the business profits and is subject to taxes.
Generally, Sole Proprietors have limited resources. You are subject to your own limitations of skills, capabilities and capital.
As a sole proprietor dies so does the business. The successors can only sell assets, not the business as a going concern.
Many businesses start out as sole proprietorships and later change to other entities as they grow.
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