Business founders and owners face the challenging task of choosing the right business structure when starting a business. With the chosen business structure determining the business’s legal rights and responsibilities, choosing the wrong one can be costly. In essence, the choice affects everything from legal liability and taxation to how a business operates and grows.
Besides factors like control, liability; proposed business activities, size, and industry help determine the right business structure for you. Some of the most common business structures in Arizona include limited liability company (LLC), corporation, and sole proprietorship.
- Sole Proprietorship
A sole proprietorship is the most common business structure, especially for freelancers, consultants, and small, single-owned businesses. It is also the simplest to start and operate. In a sole proprietorship, there is no legal distinction between the owner and the business. This means the owner personally assumes all income and liabilities.
Pros:
- It is easy and inexpensive to start. There is no requirement to register the business.
- It gives you full management control and decision-making authority
- It has minimal reporting requirements, including an easier tax setup
- It is easy to dissolve or close. You only need to pay all debts, claims, and taxes owed
Cons:
- It has no liability protection, meaning you are personally responsible for all legal and financial obligations, including debts
- It is harder to secure financing or attract investors. Banks may be hesitant to fund a single-owned business.
- It is harder to sell or transfer the business to someone else. Typically, a sole proprietorship is attached to an individual, including the name and other associations that might be hard to hand down.
- Limited Liability Company (LLC)
An LLC is a flexible business structure that combines the elements of a corporation and a sole proprietorship. An LLC has the personal liability protection of a corporation and the tax simplicity of a sole proprietorship. The business structure also provides management flexibility. LLCs are a popular structure for small-to mid-sized businesses.
Pros:
- It gives owners or members limited personal liability. The law considers LLCs as separate legal entities meaning owners are not personally liable for the company’s liabilities and debt obligations.
- They are subject to pass-through taxation. Tax liability is passed to members and taxation is at each owner or member tax rate. Owners are also not subject to double taxation as LLCs don’t pay federal corporate income tax.
- Fewer formalities than in corporations. LLCs are easier to form and have less paperwork compared to corporations.
Cons:
- Has more requirements and fees than a sole proprietorship. Require owners to file articles of organization and register a business name.
- Potential self-employment tax obligations. The law considers members as self-employed and hence have to pay self-employment taxes unless the LLC chooses to be taxed like a corporation.
- Corporation (C-Corp and S-Corp)
A corporation is separate legal entity that is distinct from its owners or shareholders. As a separate legal entity, a corporation has specific rights and responsibilities under the law. It can make a profit, pay taxes, and have legal liabilities. While it is a complex business structure, it is popular for businesses looking to raise capital or scale significantly. In Arizona, a corporation is either a C-Corporation or an S-Corporation.
Pros:
- It offers the strongest liability protection for owners compared to other business structures
- It can raise funds through stock issuance. The ability to trade shares makes corporations attractive to investors
- Sometimes, there may be corporate tax benefits, including tax on profit lower than personal income tax
- It increases the credibility of a business. Investors may trust corporations more than other business types since they have more formal structures and processes
Cons:
- More complex and expensive to set up and operate. It has more statutory and regulatory requirements, including extensive record-keeping
- C-Corps may face double taxation on corporate profits and shareholder dividends
- S-Corps have strict eligibility rules, including a limited number of shareholders
Key Factors to Consider When Choosing a Business Structure
- Liability Protection. If protecting your assets is a priority, both LLCs and corporations offer significant advantages. A sole proprietorship does not protect you from business debts or legal claims.
- Tax Implications. Different business structures are taxed differently. Sole proprietorships and LLCs have pass-through taxation where profits are reported on the owner’s personal income tax return. C-Corporations pay taxes at the corporate level and again on shareholder dividends. S-Corporations allow profits to pass through to owners while avoiding corporate taxes, but they have limitations on ownership.
- Growth and investment goals. If you’re planning to raise venture capital, a C-Corporation offers stock issuance flexibility and is popular with investors. An LLC is a good fit for small businesses and family-owned operations as it offers enough flexibility and protection without the complexities of a corporation.
- Administrative Complexity. A sole proprietorship may require only a local business license to set up. LLCs require more formalities like annual filings and operating agreements. Corporations have even more complex requirements, including articles of incorporation, bylaws, and board meetings. The more the administrative requirements, the more a business structure is hard and expensive to set up and operate.
- Control and Management. A sole proprietorship allows owners to have total control. LLCs allow for management flexibility where either members or appointed managers run the business. Corporations have a rigid structure in which directors, officers, and shareholders have defined roles.
Why You Need the Help of a Business Lawyer
Choosing the wrong business structure can be costly, including leading to unintended tax consequences, liability problems, and compliance issues. It is therefore essential to seek the help of a skilled business incorporation lawyer when choosing a business structure. A business attorney can:
- Guide you through state-specific requirements for registrations, licensing, and ongoing compliance
- Help draft or review essential legal documents, including operating agreements
- Advise you on the tax and liability consequences of each structure
Contact a Tucson Business Formation Lawyer
Settling on a business structure is not always straightforward as you need to navigate several considerations and related legal complexities, including control, taxes, and liability protection. These concepts can be confusing for most people. However, an experienced business attorney can help you.
If you are in Tucson, AZ, contact our skilled and experienced business formation attorneys at St. Clair Law, P.C. We will guide you through the legal complexities and help you choose a business structure relevant to your circumstances and with the potential for succeed. Contact us today for a consultation and to learn more about our services.
