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The Pros and Cons of Small Business Registration
When you launch a new business, you can choose from among four structure options. These include sole proprietor, partnership, limited liability company (LLC), and corporation. Of these four types, all but sole proprietorship require business registration with the state. If you have not yet chosen the business structure you feel is best for your new company, the information below should help.
A partnership is an arrangement between two or more people to share in the expenses, profits, and losses while operating the business. State and federal governments recognize two types of business partnerships, which are general and limited.
With a general business partnership, each partner has equal responsibility for managing the company. They also accept responsibility for the debts and any other obligations of the other partners. Limited partnerships combine aspects of both the general and limited structures. General partners in this arrangement own and operate the company and assume liability, while the limited partners serve strictly as investors.
The defining feature of an LLC is that it protects members from having to surrender their personal assets if a customer sues the company (known as limited liability protection), they become delinquent on one or more accounts, or the business files for bankruptcy. This business structure combines features of a corporation with some carryover into the partnership or sole proprietor business structure.
Any individual or business entity can register an LLC, except for insurance companies and banks. Members of the LLC do not pay federal and state taxes directly. Instead, they report income, profit, and losses on their individual income tax returns.
Individuals, shareholders, and stockholders are all eligible to form a for-profit corporation. Once formed, a corporation can do the following:
- Be sued
- Borrow money from banks
- Enter into legal contracts
- Pay state and federal taxes as a business
- Sue others
Like an LLC, corporations receive legal protection from the requirement for the members to surrender personal assets in a lawsuit or other type of legal claim. If you choose to incorporate your business, you can choose from one of the structures listed below:
- Non-Profit: This structure operates as a typical company but does not exist to generate profit. Religious, charitable, and educational organizations are three typical examples of organizations that choose this structure. Any money received by a non-profit must go towards operation or expansion.
- C-corporation: As the most common type of corporation, C-corp owners receive profits, and each member pays taxes individually. The corporation itself pays taxes as a business entity.
- S-corporation: Although you incorporate the C and S types the same way, the two structures differ regarding paying taxes and liability. An S-corp can have up to 100 members, and it does not pay taxes separately. Instead, each member of an S-corp reports profits, losses, and expenses on their individual income tax return.
Now that you have a brief overview of each business structure, consider the pros and cons of registering your new company.
Pros of Business Registration
Compared to operating a sole proprietorship, registering your partnership, LLC, or corporation gives you an instant credibility boost. The reason for this is that most sole proprietors operate out of their home under their own name. Potential customers have greater trust that the business will be permanent, which in turn makes them more likely to make a purchase. This is just one of four examples of the benefits of incorporating your new company.
Except for the C-corporation, all types of business structures pay taxes at the individual level. The IRS refers to this as pass-through taxation. Registration also gives you the benefit of deducting expenses like employee benefits and insurance premiums when you file your federal and state tax returns each year.
As the owner or a partner in a partnership, LLC, or corporation, you have the flexibility to pay yourself in a way that reduces your tax burden the most. For example, you can transfer some profits to yourself and leave others in the business during a high-profit year, and withdraw them during a year when your profits are lower.
Reduced Liability for LLCs and Corporations
You worked hard to start your business, and you worked equally hard to buy your home, car, and other personal assets. You have also faithfully contributed to your retirement account every year. Registering as an LLC or corporation separates your personal and business lives by protecting assets you have in your personal name from seizure in a business lawsuit or attempts by creditors to collect funds.
Limited liability also works in reverse, meaning that someone attempting to sue you personally cannot attempt to seize your business assets. However, certain limited exceptions do apply in both situations.
The Business Remains Intact if the Partner or Members Pass Away
Since each of these three structures involves more than one person, the business does not automatically dissolve when a partner, member, or even the founder dies. Each type of business entity can replace the deceased member at the discretion of the other members. With corporations, the company remains in existence until it merges with another business, or the shareholders decide to dissolve it.
Cons of Business Registration
Registering your partnership, LLC, or corporation does come with some downsides, the most notable one being the cost associated with it. New small business owners may especially struggle with the cost after having sunk a lot of money into launching the company while not yet earning a profit. Although the fee requirements vary between business structures, they can be numerous and overwhelming.
Extensive Paperwork Obligations
From articles of incorporation to quarterly tax reports, you or your staff will spend considerable time completing paperwork required by the IRS, the federal government, or your state government. Meeting this obligation can be challenging as a new business owner trying to juggle multiple roles, which means you have the choice to hire someone or outsource the work. While necessary, the time devoted to paperwork reduces your productivity or increases costs when you hire someone else to do the work.
Your State Government Determines How You Run Your Business
Once the state receives your registration materials, you must follow all its rules regarding the daily operation of your business. Typical examples include your accounting practices, operational procedures, and management structure. Since every state has different requirements for how incorporated businesses must operate, be sure to research what your state government requires to ensure you can follow the rules and feel comfortable with them.
Restructuring Can Be a Hassle
Restructuring your business can come in many forms, such as bringing in new shareholders, changing the way you operate, or opening a new business bank account. You will need to check with your state to ensure that you do not inadvertently implement a restructuring decision that goes against its rules. Unfortunately, ignorance of state laws regarding restructuring is not a defense for not following them.
Seek Advice from Professionals First on Business Registration
Business registration is mandatory for these three business types, as is choosing a business entity. If you do not select one of these three types, sole proprietor becomes the automatic default. That means you risk losing personal assets.
The good news is that you do not need to make this decision alone or subject yourself to unnecessary risk. You are free to hire a lawyer, accountant, tax advisor, or other professional to analyze your situation and provide you with useful feedback. Just keep in mind that you need to do this before you open your business, not after you are up and running.
If you operate your company for a while and decide that the initial business entity type you chose is no longer beneficial, you can change it in most cases. Be sure to look up the laws in your state and consult with the financial professional you hired before launching your company. That person can advise you on whether the change is a prudent one and the steps you must take to make it official.