One of the first major decisions a small business owner needs to make is selecting a legal form. Individuals may operate as sole proprietors, while two or more individuals can create a partnership. Both forms are relatively simply and generally involve minimal paperwork, but they also provide little in the way of tax or liability protections. This is why many small businesses opt for a more structured form, such as a corporation or limited liability company (LLC). Selecting the best form for your small business will depend on a number of factors.
1. The Type of Business
If you’re a one-person operation that provides a service, such as a work-at-home freelance writer, then a sole proprietorship may be all you need. Such providers rarely face complex legal liability issues. But if your business involves employees, leased storefronts, or inventory, then an LLC or corporation provides important liability protection. Such entities allow you to separate business and personal assets, which is not the case with a sole proprietorship or a general partnership.
2. The Number of People Involved
As the name implies, a sole proprietor means that one person owns the business (even if he or she has employees). One person can also own a corporation or a limited liability company, as well. Additionally, if there are two or more owners, they could either form a partnership, corporation or LLC.
If multiple owners each plan to take an active role in the business, then an LLC may be the best form of organization. Each “member” of an LLC participates in running the business according to an operating agreement signed by all of the owners. If the small business includes a number of people who simply wish to be silent partners, though—investing but not participating—then a corporation may be the better option. A corporation has shareholders, and it’s not necessary for any one shareholder to materially participate in the business.
3. Your Tax Needs
A sole proprietor is considered self-employed for federal income tax purposes. This means that a sole proprietor is taxed on 100% of the profits he or she reports in a given year. The same is true of a limited liability company; the IRS “disregards” the LLC, and instead taxes the profits earned by each member according to their share of the business.
A corporation, by contrast, is considered a wholly separate entity from its shareholders. This can be a disadvantage in that corporate profits are essentially taxed twice—once on the profits reported by the corporation, then again on any dividends distributed to individual shareholders. On the other hand, a one-person business might benefit from a corporation, as some of his or her profits can be paid as salary, which can, in some situations, lower the overall tax burden.
It’s also important to consider state tax issues. Florida imposes state income taxes on corporations but not individuals. A sole proprietor therefore pays no state income tax in Florida. But a one-person business organized as a corporation would pay a 5.5% tax on profits.
Getting the Right Advice
Every small business is different, and the selection of an organization type will depend on unique facts and circumstances. As with all important legal decisions, it’s important to work with an experienced Florida small business attorney who can advise you on the best option for your situation. Contact John S. Sarrett in Naples today if you have any questions.