Starting a new business venture is extremely exciting. However, if you are like most entrepreneurs, setting up the legal structure of your new business is less than thrilling.
You may be tempted to avoid the issue completely, or to choose your legal structure based on a friend’s advice. The problem with this is that they may not really know what they are talking about.
As a small business owner, you may hurt yourself and your new business if you don’t fully understand the basics of business entities and how to choose the right business structure.
If you want to make sure you choose the right business entity, then be sure to avoid the mistakes listed here.
1. Not Fully Understanding the Possible Tax Issues
You may think that you can pay fewer taxes if you choose a particular business entity. However, this isn’t necessarily the case. Here, you can learn some basic information about business entity taxation, but it’s still a good idea to work with an accountant or business lawyer before choosing a tax structure.
- Sole Proprietorship and General Partnership: Called a “disregarded entity,” owners of these report business expenses and income on personal tax returns and pay tax on profits.
- C Corp: These are taxed in two ways. You will pay income tax on profits and on any dividends paid to owners or shareholders.
- S Corp: No corporate income tax is paid on these and all profits pass through the shareholders’ personal tax returns.
- LLC: This is automatically taxed the same way as a partnership or sole proprietor, but LLCs have the option to be taxed as an S or C corporation.
Working with your attorney or accountant can help you determine which tax structure is right for your needs.
2. Believing a Formal Business Entity is Not Necessary
If you have a business that is a sole proprietorship or a general partnership, then you and your business are considered one and the same. What this also means is that your personal assets are at risk if your business happens to be sued, or if it is unable to pay off debts.
If you opt to form a business entity, such as a LLP, LLC or corporation, then your business is considered legally separate from you. If a judgement occurs against your business, you may lose any money invested in it, but you won’t lose your personal savings, car or house.
Failing to form a business entity may be a huge mistake if you have partners or if you run a solo business with large financial obligations or legal exposure.
Limited partnerships offer limited liability for the “limited partners,” but doesn’t limit liability for the general partners.
3. Believing Your Business Entity Provides Protection Against All Risks
One of the primary reasons you should form a business entity is to protect your personal assets if there is a judgment or lawsuit against your business. While the business entity you choose may provide some safeguards, it won’t provide protection against everything.
For example, if you do something wrong or are accused of being negligent, the business entity won’t provide protection. Also, it won’t help if your business suffers due to a storm or fire. That’s why you also need business insurance, in addition to the formation of a business entity.
If you are forming a business, then choosing the right business entity is important. However, more important than that, is making sure you don’t make any of the mistakes listed here. This will give your business the best chance of success.