How to set up a legally, taxably sound small business

You’ve come up with what you think is an excellent service or product, and now you want to turn your idea into a small business. There are a host of steps you must take to make your business legitimate, and one of those steps is determining the legal structure for your business. Your decision will determine how you will report your taxes. Your choice will also establish your legal obligations.

The easy route
If you have a simple service and are not selling highly regulated items like food or cars, just hang out a shingle. You don’t need a fancy legal structure to start in business. But the more complex and successful your business becomes, you will start to need the legal structure.

Of all the legal structures, the sole proprietorship is considered the most common because of the ease in setting it up. Also, the buck stops with you in that you have complete control of the business. On that same note, you are solely responsible for absorbing any, and all losses, that your business may incur. Mark Kalish, who was quoted in Entrepreneur magazine due to his experience in helping startups choose the appropriate legal structure, said sole proprietorships would always be his first option. This is his reasoning: “If you’re the sole proprietor and you own 100 percent of the business, and you’re not in a business where a good umbrella insurance policy couldn’t take care of potential liability problems, I would recommend a sole proprietorship. There’s no real reason to encumber yourself with all the reporting requirements of a corporation unless you’re benefiting from tax implications or protection from liability.”

More difficult structures
Corporations: Of all the structures at your disposal, forming as a corporation is one of the least attractive ways to go for most small business owners. The main reasons relate to the costs and the extensive amount of record keeping involved.

Then there is the issue of double taxation. If you form as a corporation, your corporation is taxed if it makes a profit. And then any dividends that are distributed to shareholders are also taxed.

Mitigating these challenges is that members of the corporation, shareholders, generally have no personal liabilities.

Partnerships: Unless you expect to have many passive investors, limited partnerships are generally not the best choice for a new business because of all the required filings and administrative complexities. If you have two or more partners who want to be actively involved, a general partnership would be much easier to form.

Good alternative
Observers point the S Corp structure as an alternative to the corporation. This formation allows you and your shareholders to pass profits, losses, deductions, and credits through to their shareholders to include on their personal tax returns.

The least liability
As its name states, the designation of being a limited liability company (LLC) means that you, as the owner, can’t be held personally liable for debts, or even court judgements incurred by your business. This is one of the reasons the structure is becoming the structure of choice for small business ow ners. Also, the LLC structure allows any profits and losses to be taxed through your personal federal tax returns, instead of the business itself being taxed.

Keep this in mind about LLCs. The IRS does not consider them to be a distinct separate entity for tax purposes, explains RocketLawyer.com. “This means that, at least initially, the IRS will not tax the LLC directly. Instead, members of the LLC get to determine how they want to be taxed. There are several options,” according to RocketLawyer’s website. These options include single member LLC, partnership, and corporation.