by Jill Hendrix

#103, 10 September 2007

Organizing Your Business
Part III: Picking Your Business Structure

How to Start a Clicks-and-Bricks Used Bookstore Series

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Now that you've written your bookstore business plan, chosen your name, and assembled your power team, it's time to pick the legal structure of your business. Will you be a sole proprietorship, a partnership, a limited liability company (LLC), a corporation or an S corporation?

Factors to consider when choosing your business structure include: number of owners, organizational costs, taxation, and liability. Choosing your business structure has tax and legal implications (which are subject to change), so consult your attorney and accountant before finalizing your decision.

A sole proprietorship is a business structure that allows only a single owner. The business and the owner are legally considered the same entity, so unless your business name is exactly the same as your legal name, you will need to file a DBA (doing business as) registration with your state and/or county. When reporting yearly profit and loss from your business, you simply report it on Schedule C of your IRS Form 1040. Throughout the year you will estimate your tax liability and file a 1040-ES form with accompanying payment each quarter. The disadvantages of a sole proprietorship include the following:

  • The sole proprietor is legally responsible for all debts against the business and his or her personal assets are at risk.
  • Adding investors and/or creating employee stock option plans will likely require a change in business structure.
  • The owner's medical insurance premiums are not directly tax deductible from business income (they can be deducted as an adjustment to income but do not reduce self-employment tax).
  • The sole proprietor must pay tax on all profits, even those retained by the business to cover future expenses or expansion.
  • If you are actively involved in running the business, you will owe self-employment tax to cover the Medicare and Social Security contribution that an employer would usually pay.

A partnership is a business structure that requires two or more owners. Partnerships have the organizational cost of having a legal partnership agreement drawn up that governs how decisions will be made, disputes resolved, new partners admitted, existing partners bought out, etc. At tax time, the partnership will have to file a Form 1065: Partnership Return of Income and Schedule K-1 which shows each partner's share of the profit and losses. Each partner in turn will report his or her share of profits on Schedule E of his or her personal IRS Form 1040. Like sole proprietors, partners are each responsible for making a quarterly estimated tax payment. The partnership can usually raise additional financing by adding one or more partners. Disadvantages of a partnership include the following:

  • Partners are liable for the actions of other partners and personal assets are at risk.
  • Profits must be shared per the partnership agreement.
  • Partnership disagreements may cause havoc with the business.
  • The death or withdrawal of a partner may negatively affect the business.
  • The partners must pay tax on all profits, even those retained by the business.
  • Partners actively involved in running the business will owe self-employment tax to cover the Medicare and Social Security contribution that an employer would usually pay.
  • The partner's medical insurance premiums are not directly tax deductible from business income (they can be deducted as an adjustment to income but do not reduce self-employment tax).

A corporation is considered under law to be its own separate entity apart from that of its owners. It can be sued, taxed, and can enter into contractual agreements. The owners of a corporation are known as shareholders. The shareholders elect a board of directors to oversee the business. Shareholders typically have limited liability for the corporation's debts. Corporations can raise additional funds through the sale of stock; they can also deduct the full cost of benefits provided to officers and employees. If the business will be retaining profits from year to year, then the lower initial corporate tax rate may be beneficial. Shareholders who work for the corporation are paid salaries and have taxes withheld just like regular employees of any company; they are not subject to self-employment tax. Disadvantages of a corporation include the following:

  • Corporations, which are chartered by the state in which they are headquartered, usually have the highest organizational costs of all the business structures.
  • A corporation is the only business structure that must pay its own income taxes on profits. It files IRS Form 1120 and also must make estimated quarterly tax payments.
  • Dividends paid to shareholders are not deductible from business income, thus taxes may have to be paid twice - once by the corporation and then again by the recipients. (Note: This is usually an issue only for larger corporations.)
  • Officers of the corporation can be held personally liable for their actions.
  • Corporations are monitored by federal, state, and sometimes local agencies and may have more paperwork and associated operational costs than other business structures.



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