In today’s world, businesses are held accountable just as their owners are. They pay taxes, follow special laws, and have specific expectations surrounding their daily practices. The degree to which your business is tied to you depends on the legal entity you choose for it. Some have tax advantages, some provide more protection, and some open the door for financial investments. To make the best choice for your company, you will need to weigh your options and pick the best path for your plan.
A sole proprietorship is the simplest legal entity that you can choose for your business and basically requires nothing to form - it is simply you doing business for yourself. You do, however, still need to evaluate whether there are industry-specific or regional licenses that you need to obtain to do business. Taxes are simple with a sole proprietorship and require no special filings, but you should be aware of the liability attached - you are basically held totally accountable for anything and everything that happens. Sole proprietorships are great for people just starting out, freelance workers, and consultants.
A partnership is a business with two or more people sharing ownership. Some states require taxes to be filed for the business, so you will need to file for a tax identification number from the IRS for the business if you are operating within the U.S. and a Business Number if you are operating in Canada. Depending on your plans for the partnership, you can arrange for different amounts of liability or financial investments. With partnerships, one of the most important aspects is a Partnership Agreement, which can be different and unique for each and every partnership.
An LLC is a legal status that protects owners from certain liability but still ties profits directly to the owners, similar to a partnership or sole proprietorship. It is one of the most common legal designations for small businesses because it offers many of the benefits of a sole proprietorship but with the protection of a corporation.
A C Corporation is the most independent legal status a business can have. With C Corporation status, a business is fully responsible for itself so the owners are not tied to it through liability. C Corporations are typically the most attractive companies for financial investors, but also have complex legal and tax obligations so they are usually reserved for companies that are larger with multiple employees and investors. The biggest down side of a C Corporation is that it suffers from double taxation - the government will first tax the company as a whole and then will tax the profits paid out to shareholders through their own personal tax filings. C Corporations have strict registration requirements so it is important to check with the state, federal, and local governments, as well as licenses that are industry-specific.
An S Corporation is similar to a C Corporation with one major distinction - profits are able to flow directly to the owners, allowing owners to avoid double taxation. There are rules that pertain to how owners are paid, however, so you need to first make sure that structure will work for your business. Avoiding double taxation also comes with limitations - with an S Corporation, you are limited to the number and type of investors and owners you can have.
After you have weighed your options and picked the right legal entity for your business, you will need to obtain an Article of Incorporation which will make this legal designation official in the eyes of the government. If you plan to incorporate your business within the U.S., you will file your designation at the state level. The U.S. Small Business Administration has a great list of state requirements that can walk you through the proper steps. If you are incorporating a business in Canada, you have the option of incorporating at the federal or provincial level. Federal incorporation needs to be filed with Corporations Canada and provincial incorporation needs to be filed with whichever province you are operating in. A list of online application options for each province can be found here.
Choosing your business’ legal status is an important piece of starting your business both for legal and financial reasons, so it should not be taken lightly. Many lawyers and accountants specialize in business designations, so it is important to consult an expert if you are going down a path you are not familiar with. Taxes, liabilities, and regulations all affect your bottom line so you want to make sure you pick the path that will lead to the most profit.
All information provided in this article is for educational purposes and should not be used as the sole resource in making a decision. It is important to consult a lawyer and accountant before all major business decisions. Please refer to our Terms of Service for more details.