When you're a homebased business owner, you have several options when it comes to the formal structure of your business: sole proprietorship, limited liability company (LLC) or corporation. If you're going into business with someone else, you should definitely consider a LLC or a limited liability partnership (LLP), as well as a traditional partnership. Here are the key issues you should consider when weighing which would be best for you:
- Cost to form the business
- Complexity and time involved to maintain the legal structure
- Potential personal liability in the event of litigation or business failure
- Effect on obtaining a loan or attracting investors
- Business image
- Tax consequences, including the cost of tax preparation by a professional
Let's compare each of the business forms available in terms of these factors:
Operating as a sole proprietor will cost you the least to start and maintain. It's also the cheapest when it comes to having your tax returns prepared--you'll simply file a schedule C to go along with your 1040 form. A corporation, on the other hand, costs the most to start and maintain. The cost of operating an LLC will be somewhere between the two, although some states, like California, tax LLCs like corporations so the costs may be comparable to that of corporations.
Even if you fail to get a business license or register a fictitious name for your business--if you're using one--in the eyes of the government, you're automatically a sole proprietor. That's how easy it is--there's no paperwork to fill out and file. On the other hand, forming an LLC or incorporating requires that legal paperwork be drawn up and that you maintain your legal status, which involves ongoing paperwork.
As a sole proprietor, you're personally responsible for everything from business debts and damages to lawsuits. Your best protection is to be adequately insured. By incorporation or forming an LLC, your major advantage is that you can at least theoretically protect your personal assets, such as your home and your savings, from business losses. The reason this may be only theoretical is that in order to get a bank loan and sometimes even credit, the grantor may insist that you sign the paperwork as an individual in addition to signing in the name of your company.
If finding investors is a factor in your decision, incorporating is the way to go: The corporation's permanence and ability to extend beyond your lifetime alone make it more desirable.
Business image is another factor favoring incorporating. People associate size and permanence with the terms "Inc." or "Corp." at the end of your business's name.
The advantages of being taxed like a corporation generally don't begin to kick in until you're producing more than $100,000 a year in income for yourself. To avoid paying double taxes--first as a corporation on its income and then individually on what you collect as dividend income from the corporation--your tax professional is apt to advise you to choose subchapter S tax treatment. This means you'll pay your taxes as if you were a sole proprietor. Since tax policies vary among states, check out how your state treats LLCs and corporations.
If you're teaming up with someone else, then you'll need to weigh the advantages and disadvantages of forming a partnership, a limited liability company or a corporation. While partnerships are the least expensive and simplest to start, the advantage of an LLC, LLP or a corporation is that you can limit your personal liability.
Finally, before deciding on any of these options, it's best to consult an attorney and tax professional who's well-versed in small-business or homebased business issues and/or read one of the specialty legal books available at www.nolo.com.
After applying these considerations to your situation, you may find you make a different decision on how to organize your business from another homebased business owner, even if you're starting the same kind of business in the same town at the same time.
Authors and career coaches Paul and Sarah Edwards are Entrepreneur.com's "Homebased Business" columnists. Their latest book is The Best Home Businesses for People 50+. Contact them at www.workingfromhome.com.