One of the first decisions you have to make when starting a new business is the type of entity structure to establish.  There are many thoughts and questions that may run through your head.  “I don’t want to pay taxes” might be the first one.  First off, come to terms that you are going to pay taxes.  You live in this wonderful country we like to call America and there is going to be a small price to pay for it.  Hopefully Congress doesn’t get in the way and raise taxes… but I digress.  While you will pay taxes, assuming you are profitable – and profitability is the goal in business right? – you shouldn’t pay more taxes than necessary. 

The second question might be “How do I reduce my liability, I don’t want to be on the line for this?” You have some options, each offering a different level of liability on the owners.

The third though might be regarding the simplicity or complexity of the business structure.  You can spend a good chunk of change in lawyer fees for a more complex structure, or you can be cheap and give the lawyers nothing. 

You have to weigh the importance of these factors to your business and make a choice, hopefully the right one.  What is the right one?  Only you can answer that question.

On our website, we have a chart that gives a list of factors to consider when choosing an entity type for your business.  There’s a lot to consider and the chart can’t cover all the issues, but it’s a start.

There are five main entity structures to choose from:

• Sole proprietorship (self employed)
• C-Corporation
• S-Corporation
• General partnership
• Limited liability company

This post will go through some (not all) advantages and disadvantages of the sole proprietorship structure.  Future blogs will go through the other structures.

ADVANTAGES:

• Taxed once – all business profits and losses flow through to the sole proprietor (also disadvantages).
• Formality is limited – there is relatively very little formality to starting a business as a sole proprietor.
• Free to transfer interest – generally, you can transfer your interest in the business to another entity without cost.
• Can use cash basis – for tax purposes (in most cases)

DISADVANTAGES:

• Personal liability – the sole proprietor is personally liable for all business obligations.  This means you are sued personally if the business is sued.
• Social security tax –profits are subject to Social Security and Medicare tax.
• Life of entity – the business does not exist past the life of the sole proprietor.
• Bankruptcy – there is no bankruptcy option for a sole proprietorship.  The owner must personally file for bankruptcy under Federal Bankruptcy Statutes.
• Higher IRS audit risk – the IRS typically audits more individuals with a Schedule C (how you report your income and expenses for a sole proprietorship) than other business structures.  These audits are consistently productive for the IRS.
• Only one owner – the minute you add another owner, you are forced to select a different entity structure.

 Always consult a professional when starting a business to consider all your options and the advantages and disadvantages of each.

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