STARTING A BUSINESS?

Before you start a new business, there are a number of preliminary decisions to be made. One of the first choices you will face is the legal form in which you will operate the business.  Should it be an unincorporated sole proprietorship, a partnership, a limited liability company, a regular corporation, or an S corporation?  Contrary to what many believe, there is no easy answer to this question.  Each of these forms has both tax and non-tax advantages and disadvantages that must be weighed in conjunction with your own plans and personal situation.

Sole proprietorships are the easiest and cheapest business form to set up, and they can be operated with few formalities.  Bookkeeping is simpler with this form of business because no balance is required by the IRS, and the income is reported on the owner’s personal tax return.  However, they offer no personal liability protection and don't allow you to get many of the tax benefits that are available to certain corporations.

Partnerships offer many of the same advantages and disadvantages as the sole proprietorship, but they allow the business to be owned and run by more than one person. Also, the liability problem can be overcome to a certain extent by forming a limited partnership, but partners whose liability is limited cannot be involved in actively managing the business.  

Limited liability company’s, which are approved for use in almost every state, offer what many see as the best alternative for the typical small business.  If there are two or more owners, they are taxed as partnerships while the managing members' personal assets remain fully protected from business creditors.  If there is only a single owner, they can be taxed like sole proprietorships on the owner’s personal tax return.   

S corporations also offer liability protection, without a separate corporate tax.  Like partners and sole proprietors, however, more-than 2% S corporation shareholders are ineligible for tax-favored fringe benefits.  Another potential drawback of S corporations results from limitations on the number and kind of permissible shareholders. These restrictions can limit an S corporation's growth potential and access to capital in some businesses.  In others, however, an S corporation can be a key ingredient toward success.

C corporations do not have the shareholder restrictions that apply to S corporations.  However, unlike any of the entities above (where taxable income is taxed at the individual’s tax rate and distributions are generally not taxed) they are subject to a double system of taxation.  That is, their profits are subject to income tax at the corporate level, and are also taxed to the shareholders if distributed as dividends.  But if profits are to be plowed back into the business to foster the company's growth, the tax price is usually lower than with an S corporation. In many cases the double tax can be substantially minimized. An advantage to this form of operation is that shareholder-employees are entitled to tax-advantaged corporate-type fringe benefits, such as medical coverage, disability insurance and group-term life.

Many times a business can switch from one form of business to another fairly easily.  Other times, a change in form can be quite difficult and costly.  Therefore, you should get all the facts to make an informed decision before beginning business.

Many factors, tax and non-tax, go into making this decision.  Will you have employees?  Does your business run substantial risk of lawsuit?  Do you plan to make a long term career from this business, or is it something you will sell or let die in a few years?  Will your customers feel more comfortable dealing with a certain type of business?

Besides the question of choosing a form of entity for your new business, there are many other tax decisions to be made, and much planning to ensure that you meet your income and payroll tax reporting and compliance chores properly.  

How will you handle your start-up costs?  

Will your workers be employees or independent contractors? Can you qualify for a home office deduction?  

Should you set up a qualified retirement plan, and, if so, what kind?

In addition, various filings will be required by federal, state and local governments to apply for business licenses and identification numbers.  Because of the complexities, you should always enlist the help of professional advisors when starting a business.  If these matters are taken care of at the beginning, it will save lots of administrative headaches and costs later.