You are one of the millions of business owners in the United States.
You had the idea, created a business plan, arranged for office or other space and researched possible financing options. Now it’s time for you to formalize the structure of your business.
The business structure you choose influences everything from day-to-day operations, to taxes, to how much of your personal assets are at risk. You should choose a business structure that gives you the right balance of legal protections and benefits. There are four main options in Massachusetts.
- Sole Proprietorship
- Limited Liability Company
Sole Proprietorship. A sole proprietorship is easy to form and gives you complete control of your business. You are automatically considered to be a sole proprietorship if you do business activities but don’t register as any other kind of business. However, you may need to register within the town where you do business.
There is no distinction between you and your business from a legal perspective. This means your business assets and liabilities are not separate from your personal assets and liabilities. You can be held personally liable for the debts and obligations of the business. This is the biggest downside to the sole proprietorship, although this risk can be mitigated to some degree with insurance. The owner will also pay self-employment tax on all business profits and may pay more in taxes than other entities.
Partnerships. A partnership consists of two or more people conducting a business together. Like the sole proprietorship, there is no formal filing with the Commonwealth. However, it is prudent for partners to enter into a formal agreement to articulate the rights and obligations of the members. If you form a general partnership, each of the partner’s personal assets are potentially at risk. You can also decide to form a limited partnership where the liability of the limited partners is limited to their investment. The general partner has unlimited liability. The partnership itself does not pay tax from business income. Instead, profits and losses are passed through to the owners’ personal tax returns.
Corporations. A corporation is a legal business entity that is separate and distinct from its owners (shareholders). While corporations are more expensive and complicated to form, the major advantage is that the corporation protects the owner’s personal assets from liability. Frequently, a small corporation will elect S corporation status. This election provides the ability for the profits of the corporation to “pass through” to the individual owners.
To form a corporation, articles of incorporation need to be filed with the Secretary of State.
Corporations also require more extensive record-keeping, operational processes, and reporting than sole proprietorships or partnerships.
The Limited Liability Company (LLC) is a popular business entity choice. It provides the liability protection of a corporation and less extensive record keeping. The Limited Liability Company does not have the same burdens of a corporation such as holding regular board meetings, shareholders’ meetings, and maintaining meeting minutes. To form a Massachusetts LLC, a Certificate of Organization need to be filed with the Secretary of State. There is an annual fee and reporting requirement. Income can be taxed as a pass-through entity like the sole proprietorship or partnership or as an S corporation.
The choice of entity involves a complex analysis that involves tax, industry, investor and financing considerations. It is prudent to consult with an attorney and accountant prior to making this decision. In addition to choosing a business structure, you should formalize the relationship with your business “partners” by entering into the appropriate operating agreement for your business. This will formalize how you will work together and provide for succession in the future.