One of the first steps in establishing a home-based business idea is deciding which type of business entity you will set up. There are several different categories of business entities, and each one has distinctive pros and cons.
Sole proprietorships are popular among home-based businesses. They are easy to establish, and taxes from sole proprietorships can be reported on your personal tax return. However, you will need to pay self-employment tax in addition to your regular income tax.
Although establishing a sole proprietorship is easy, getting financing for a sole proprietorship can be difficult, and you are personally liable for your business. If you are sued by a customer, or if you run into financial problems with your business, your creditors can sue you.
Partnerships can be broken down into two categories, depending on how the equity in your company is held.
- General partnerships are for businesses with more than one owner. The partners own and operate the business, and they are still personally liable for the business.
- Limited partnerships are for businesses with investors. The ownership of the investors is “limited,” and the owner or owners maintain control of the company’s operations.
Corporations provide their owners with personal protection against liability for the obligations of the corporation, but they can be more difficult and costly to set up. You will need to issue shares in your company and assign members to your board of directors. You must also follow proper corporate formalities.
There are three basic types of corporations:
- A C corporation protects your personal assets if the business goes bankrupt or faces a lawsuit. However, C corporations face some tax disadvantages. Since you share your profits with your shareholders, you are taxed twice: first on your regular business earnings, and then again on payments to your shareholders.
- S corporations offer the same legal protections as C corporations, but S corporations have only one level of tax generally. S corporations offer more tax benefits than C corporations.
- Limited liability corporations, or LLCs, are a hybrid of a limited partnership and a C corporation. LLCs can have an unlimited number of shareholders and are not subject to the C corporation’s double-taxation problem.
Before deciding which type of entity is best for your company, check with your legal counsel and your tax advisor.
For more insights, read Frank Ross’s “The Home-Based Business Blog” on AllBusiness.com.