50 Startup Secrets

Chooosing Your Legal Structure

Do you really need to incorporate or not? Selecting the right legal structure for your company's operations is an inportant first step. Start by asking yourself which legal jurisdictionmakes sense to set up in. We've all heard about incorporating in Delaware or Nevada, but the short answer for a small business is, "stay at home". Incorporating in another state for tax purposes might make sense for companies with lots of investors, but you'll have more control and convenience if you legally base your startup where you are actually located. With this decision made, use the following tips to help you settle on a legal structure:

16. Consider your appetite for liability. The various legal entities all offer entrepreneurs different protections against liability. A corporation or an LLC offers you the best protection against being held personally liable for actions by employees or others. But no form of organization completely shields entrepreneurs from personal liability. The entity affects your liability for the acts of employees, partners and contractors. A sole proprietorship provides no liability shield. A partnership makes you liable not only for your wrongful acts, but for those of your partner as well. If you don't have employees, contractors or partners, a corporation or LLC won't provide much liability benefit.

17. You'll also need to consider access to capital. As a sole proprietor, debt financing is the only way you can raise money for your business. Partnerships let you borrow as well as ask other partners for capital.Corporations and LLCs have much greater flexibility in acquiring additional investments as these entities can sell equity to others to generate capital. If this is an important factor, this will help determine the entity you select."

18. How much paperwork can you handle? A sole proprietorship is the most simple, as compliance is low. Business licenses and Doing Business As certificates are the only red tape sole proprietors would face in most cases. When you set up a partnership, an LLC or a corporation, though, State, local and federal regulation filing requirements rise sharply .

19. What are the tax implications? As a sole pro prietor or partner, you will have full personal tax liability for the business's profits. One upside is that you can deduct the business's losses on your personal tax return. C corporations ara a taxable entity unto themselves. If the corporation distributes money to you or other owners as a dividend, you pay taxes again, so the money is taxed twice. S corporation dividends and distributions are treated as passive income, so they aren't subject to payroll taxes, and with an S corporation, profits pass directly to you without being taxed at the corporate level. LLCs can be set up similar to C corporations or like pass-through S corporations, but the LLC that elects to be taxed as a pass-through doesn't get as favorable treatment as an S corporation.. S corporations have a special risk for passive owners because they will be taxed on their distributable share of the corporation's earnings. If the S corporation's active owner-managers opt to put profits back into the company instead of distributing them to shareholders, a passive owner could have to pay taxes on money he or she didn't receive. So if you set up an S corporation, make sure you are actively in control of it, or incorporate safeguards to make sure you'll receive enough money to cover taxes on distributable profits. If you're uncertain what option is best for you, consult an attorney familiar with small-business issues.