Ever get bogged down by choices? I mean it’s great to have the option to choose. But sometimes having too many options can be a curse. You are faced with making choices everyday, whether it’s picking an ice cream flavor in a store or picking a structure for your business. The difference lies in the magnitude of risk. The wrong ice cream may not greatly affect your life, but the wrong legal structure could.
The risk of not having a registered entity exposes one’s individual/personal assets to liability. Which means that in the event that the business takes a turn for the worse, the outcome could be disastrous for your personal finances or assets.
For example, if there is a court order directing a business to pay money to someone who has sued the business, the business owner’s personal assets could be at risk if there is not enough money in the business to satisfy the court order.
My client, Christine, found herself in such a situation. Christine owns a pet store in New York. As a child, she was always passionate about pets and taking care of them. So she naturally gravitated towards owning a pet store. But because it was a passion project, Christine ran it as a sole proprietorship and did not think of registering her business.
One of her customers slipped and fell in the store during a quick stop at the store. She sued Christine for injury caused while she was in the store and for missing a few days at work because of the injury. The customer won the lawsuit and the court ordered that Christine’s business pay money to compensate the customer for her injuries.
Christine’s business, which was not registered, did not have enough money to pay the customer as ordered by the court. She had $10,000 in her personal account that she was saving to take a trip to Hawaii. Her vacation dreams came crashing down because now she would have to dip into her personal savings to pay the money to her customer.
This could have been avoided if Christine had registered her business as a separate legal entity. Christine could have opted to register her business either as an LLC, an S corp., or a C corp. She learned from her mistake and later registered her business as an LLC. But only after losing her personal savings and peace of mind.
Setting up a legal structure creates an individual entity which can sue or be sued upon and be held solely responsible for its actions. This creates a shield for individual owners and protects them in the event of financial mishap.
Even though a sole proprietorship is the most common kind of setup that small business owners who are just starting out opt for, it does not protect individual owners from the debts and liabilities of a business.
A C Corp. is a standard type of corporation which is owned by shareholders with no limits on the number of shareholders or limits on the class of shares that it can issue. This is the most flexible form of structure available. However, a C corp is taxed at 2 levels – at the corporate level when a company makes a profit and when dividends are paid to shareholders on their personal tax returns.
An S Corp. is a special type of corporation created through an IRS election. This is done to avoid double taxation like a C corp. S corp has a Pass through taxation which means that business income or loss is passed through to the shareholders who report it on their personal income tax return.
A Limited Liability Company or LLC is a hybrid type of legal structure that has limited liability like a corporation and is taxed like a partnership. This means that either the business or the individual is taxed. There is no double taxation as in a corporation where the entity is taxed as well as the owner is taxed on profits.
Now that you have these choices, you may wonder what structure is best for you. That depends on your business, the goals for your business, and tax implications given the nature of your business. You need to consult an attorney and an accountant to advise you on what is the right fit for your business.