If you have a new business, one thing is potentially on the horizon: How are you going to let your state and the Federal government let them know about it. You have to pay taxes on your income or you may have suffered first year losses but regardless, you have to report it. This is only one reason that as soon as you start your business, you’re going to have to decide what kind of legal entity it will be.
Many new business owners choose the sole proprietorship. It’s cheap and it’s convenient because it only requires the completion of a Schedule C on the owner’s personal taxes and the name of the company can be as simple as the person’s name.
Cheap and convenient isn’t always the safest or best way, though. Let’s look at four reasons why you should consider forming an LLC, corporation, or other type of business entity.
The only way to avoid having to pay business and personal taxes is to remain a sole proprietor, right? This is a common misconception among new business owners. Forming an LLC gives you pass through rights just as with a sole proprietorship. This means that you only pay taxes once.
Protection of Assets
If you’re in an industry with a large amount of litigation associated with it, you should not be a sole proprietor. Until you register your business, your family’s personal assets could be taken should you fall in to debt or have a judgment rendered against you. If you’re in the food service, medical, or professional consulting field, you should not be a sole proprietor.
There aren’t many (smart) investors who want to give money to a sole proprietor. If you are looking for venture capital or angel investor funding, considering forming a C corporation. This allows for the formal issuance of various classifications of company stock. A C corporation is also the designation of choice if you believe that your company will one day be publically traded.
Are you planning to pay some of your employees or consultants by awarding equity in your company? If that’s your plan, you need to form a C corporation. Any issuance of company equity has to be awarded by a C corporation.
For the smallest and simplest of companies, a sole proprietorship may work but most companies should form an LLC or other type of formal corporate structure.