What Type of Business are you?

Note: This article launches our January tax series and is intended to be generally informative. You should always consult your tax professional or attorney for questions specific to your own situation.

“One of these things is not like the others...”

Many of us remember this song from shows like Sesame Street or maybe from one of our elementary school teachers. And it is usually accompanied by a pile of triangles, squares and circles in different colors for us to sort out. Like those shapes and colors, businesses come in different shapes and sizes, too. There are several basic ways businesses are organized.

Keep it simple. 

A sole-proprietorship is the way many of us start our businesses, because they’re easy to set up. In a sole-proprietorship, you and your business are one. For tax purposes this means that all the income goes directly to the business owner and becomes part of their personal income. The owner pays taxes at their individual tax rate. These types of businesses usually require nothing more to set up than a quick trip to your local courthouse to get the permits and a business license. Since there is really no legal separation between you and your business, if things go sour you can not only lose your business assets, but your personal assets as well. 

Two heads are better than one.

If there’s a risk of losing your shirt by starting up your own business, why not spread that risk around a little bit? A partnership is one way to do that. Having two or more owners can allow each partner to specialize in an aspect of the business while still having access to the other’s resources and talents. Partners report their share of the business’ profits on their individual tax returns. Each partner is still personally liable for the business’ debts, but when times are tough it helps to have a friend. To maintain that friendship, most partnerships draw up a legal partnership agreement which all parties sign, though it isn’t strictly necessary.

Corporations are people too.

Well not exactly, but they are separate legal entities and have many of the same rights as people do. Since the business is separate, owners (shareholders) have limited liability, only risking what they’ve invested in the business. The corporation files its own return, and shareholders receive their share of the profit in the form of dividends. Unlike the sole-proprietorship and the partnership, these profits are taxed at the dividend rate: 28 percent for short term investment less than one year; and 15 percent for investments held longer than a year. Understandably, corporations require a bit more effort to set up. A corporate charter must be drawn up, usually by a legal professional, and then submitted to the state board in which the corporation will operate. 

The more things change… 

Business structures have evolved with the times, resulting in hybrids like the Limited Liability Corporation (LLC) and the S-Corp. These types of businesses have become popular, particularly among small business owners, because they are easier to set up and simpler to operate than a corporation, yet still allow owners to protect themselves against liability. 

What type of organizational structure is best for your business depends on a number of factors including size, the industry you’re in and what resources you have on hand when you start out. There’s nothing stopping you from changing as you go along. For more detailed information about the different types of businesses and which might be best for you, consult your tax professional or attorney.