Starting a business is rarely easy. Maybe someone has a great idea, but it takes a unique entrepreneurial spirit to get things off the ground. And one of the essential steps in that process is choosing the right legal structure for the company. Some methods of organization offer more flexibility, but less optimal tax treatment. Others protect owners from liability but require a more formal structure.
According to the U.S. Small Business Administration, the most common structures for small businesses include sole proprietorships, partnerships, and LLCs. Each has its own benefits and drawbacks, which we have outlined below.
Pros: No registration required. If you are engaged in business activities, you are operating a sole proprietorship. The owner retains complete control over operations, and profits appear on personal tax returns.
Cons: There is no line between business and personal assets. A sole proprietor is personally liable for all debts and obligations relating to their business.
Pros: Partnerships are the most straightforward option for a business with multiple owners. They are documented using a partnership agreement. Limited Liability Partnerships (LLPs) protect partners from liability for business debts, and profits pass through to individual tax returns.
Cons: Limited Partnerships give unlimited liability to one partner (the general partner), while other partners have limited liability. Partners with limited liability also have limited control over the company. A partner with unlimited liability retains more control but must pay self-employment taxes and is responsible for the debts and obligations of the business.
Limited Liability Companies (LLCs)
Pros: LLCs combine the benefits of a partnership and a corporation. They separate owners’ personal assets from the business assets, protecting them from liability for debts and obligations of the business. Profits pass through to individual tax returns, thus avoiding the “double taxation” problem of a corporation.
Cons: Members must pay self-employment taxes for Medicare and Social Security. Plus, many states limit the lifespan of LLCs.
Find the Right Structure for Your Great Idea
Finding the right organization for your business requires careful consideration. For guidance on the best way to form your business, consult a New Jersey small business attorney.