Framing The Structure

Choosing the right legal structure for your business is a complicated decision, but not necessarily as important as you might think.

Your decision should be directed mostly by two factors, liability and taxes. The important thing to remember is that you can change this at any time during the life of your business. So if you choose one it does not mean you are stuck. So the best advice to follow is to start simple, and adjust later.

You have more important things to consider during startup, wasting your time on this choice is needless.

That said, there are several that you can choose from, listed below in order from easiest to the more complicated to organize and run:

• Sole Proprietorship
• Partnership
• Limited Liability Company
• S Corporation
• C Corporation

There are some more obscure structures designed to fit special circumstance businesses, but for our purposes we will not get into detail on those.

For my company’s purposes a partnership should fit the best. I had looked into the LLC because I wanted to limit my personal liability. I found through my research, however, that this is basically achieved through obtaining liability insurance. There are a couple of points that make me reconsider the LLC structure though, which is tax and liability of my partner.

My partner has more assets than I do, which means if the company were to go under he would pay out more than I would for any debts outstanding. Also, Limited Liability Companies retain flexible tax structure.

With a partnership income flows through to the owners, but Limited Liability Companies can be taxed this way or as a separate entity like a corporation. Self employment tax alone is currently at 15.30%, which only applies to the first $97,500.

“Half of the self-employment tax is allowed as a deduction against self-employment income so only 92.35% of the self-employment income is taxable at 15.30%, an effective tax rate of about 14.13%. However, this benefit disappears if self-employment income exceeds $105,577, since the entire applicable amount of $97,500 will be taxed at 15.30%.” (http://taxes.about.com/od/2008taxes/qt/2008_tax_rates.htm)

Don’t forget that this is in addition to your ordinary income taxes. For more info on ordinary tax rates go to this website.

http://taxes.about.com/od/2008taxes/qt/2008_tax_rates.htm

So let’s use an example here, say in our first year our company made $50k. Most of this we would reinvest in the company anyway. In a partnership we would each pay approximately $3,532. 50 in self employment and $4,255.25 in income tax, that’s $15,575.5 in total combined tax liability. On the other hand, if it is an LLC taxed as a corporation and we leave the money in the company the total tax liability becomes $7,500.

This is a simple example however and does not take into account any deductions for business expenses. There are many factors to consider, however if you and your business partners cannot agree, then move on, and use the simplest possible solution.

-Rebecca