The Different Business Structures and their Implications
Zig Ziglar once said, “If you are not willing to learn, no one can help you. If you are determined to learn, no one can stop you.”
Owning a business comes with a lot of perks, and being your own boss is the best one. On the flip side, it may seem that you need to be a multi-talented person to learn and perform many tasks yourself. But with a good financial plan and strategy you’re on the right track, but, you don’t need to do everything yourself. If you are a lone wolf, consider having a business coach as your second brain. Check here why you need one as a small business owner.
As a small business owner, you do not need to be a financial expert. but, whether you like it or not, you will need to have a CEO level of mastery with finance. First, you’ll need to dive into understanding the kinds and differentiation of business structures and their financial implications. This will help you have an idea of what kind of business structure you should set up (or change to if you’ve already started your business).
Business structure means a structure of an organization that is recognized in your jurisdiction legally. We have business structuring for differentiation purposes, from legal to tax liabilities which will be tackled below. The following are the 4 main forms of business structures in the US, what they mean, and their financial implications:
1. Sole Proprietorship
You are the only owner of your business. And as the sole owner/proprietor, you are personally liable for any obligations incurred by your business. If your business is doing good, you get to enjoy the fruits of your hard work but if a business is sued, you will be on the line to use your personal assets to settle any obligations.
Since you are a sole proprietor, you do not pay business taxes but you must pay taxes at the personal tax rate.
If your business has a loss of $10,000, and you have another income of $60,000, then personally, you will just have to pay the tax from the net amount which is $50,000.
In a partnership business structure, you have a buddy/partner in running the business. As partners, you are both liable for your business obligations, transactions, and even your partner’s actions as well as your own action.
You have similar financial implications with a sole proprietorship if you select this structure, but since you have a partner, you are personally liable not on the whole amount of Net Income but a portion thereof based on your ownership or distribution of the business profits. Your portion will be taxed at the same rate as your personal tax rate.
A corporation is an independent legal entity, which is separate from its owners/shareholders. A corporation can retain some of its profits without the owner/shareholders paying tax on them.
If the shareholders die, sell the shares, or become disabled, the corporation still continues to exist.
This requires more regulations and tax compliance requirements that you must adhere to.
As a corporation, you need to file a corporate income tax (business tax) and your taxable income for the corporation gets taxed at the corporate rate, which increases as the income of the corporation increases.
4. Limited Liability Corporation
Limited Liability Corporation (LLC) is a hybrid entity with features of a partnership and a corporation. This structure is super popular. For tax purposes, the Internal Revenue Services (IRS) agency treats an LLC as either a sole proprietorship, a partnership, or if the LLC decides so, as an S-corporation (you can elect to be treated as an S-corporation for tax purposes).
LLC is considered a pass-through tax entity, which means that profits pass through the company to its individual members.
Individual members must report their share of the profit and pay accordingly.
All of those structures from the sole proprietorship, partnership, corporations, and limited liability corporation come with different tax and financial implications and legal responsibilities from you as the business owner. Understanding the basic business structures can help you prepare your financial plan and strategy more effectively.
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