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So you have a great idea for a small business and now it’s time to get started. One of the first things you need to decide is how are you going to structure your business. This is commonly referred to as a “choice of entity”.
Small businesses often choose between operating as a sole proprietorship or form a LLC.
This is the simplest and easiest choice – if you started a business and haven’t formed any legal structure of business structure, then you’re operating as sole proprietor.
Advantages of Sole Proprietor
- Ease of Set-Up: All you have to do is start your business and you’re a sole proprietor. There is no formal document to file to statr nothing to file unless you’re operating under a trade name. If you have a trade name, then you need to register your trade in the town you operate the business.
- Pass-through Taxation: All the income that is earned by the business is taxed as personal income to the owner.
However, one of the biggest drawbacks of operating as sole proprietor is there is no liability protection for the business owner. This means that the owner is personally liable for liabilities of the small business, which could can put their personal assets at risk.
For this reason, a sole proprietor is only a practical option for small businesses with a low liability risk
Limited Liability Company (“LLC”)
An LLC is often a good and popular because its considered the best of both worlds in terms of tax advantages and liability protection for the owner. To form an LLC, you need to file Articles of Organization with the Secretary of State. An LLC combines the pass-through taxation of a sole proprietorship with the limited liability of a corporation.
Advantages of an LLC
- Member Liability: Members (owners) are not personally liable for debts, obligations, or liabilities of an LLC. Members can take part in the operation of the LLC without the risk of personal liability.
- Pass-through Taxation: The LLC itself is not taxed because the income earned by the LLC is taxed as if it were income to the business owner. This is desirable because individuals tax rates are often lower than corporate tax rates. Also, an LLC avoids double taxation, which occurs with a corporation
- Centralized Management: The management of an LLC can be delegated to managers, who may have different powers, rights and duties. The managers may or not be members of the LLC. This provides great flexibility as to how the business is managed as degree of centralized management is subject to the individuals organizing the LLC.
In most instances, an LLC is going to be a better option for your small business because of the liability protection it provides for the owners.
It is a good idea to consult with an attorney when starting your business and discuss which business entity is best for your business.