You may have started your business as a simple sole proprietorship that files its taxes as a Schedule C on your Form 1040. As your business grows, you may want to change the structure. Here are several scenarios where it may make sense to do just that.
Reasons to Create Business Entities
- Establishing limited liability. The primary reason businesses form corporations and limited liability companies is to create a separate legal entity that provides legal protection. If your business receives a legal summons for a claim, for example, having limited liability may protect your personal assets like your home and car.
- Hiring your first employee. Businesses are generally liable for their employees’ actions taken on behalf of the company. If an employee performs an act that causes an outside party to sue your business, the outside party can come after your personal assets to satisfy the lawsuit if you don’t have limited liability. You should, therefore, incorporate your business if you anticipate hiring your first employee in the near future.
- Establishing credibility. Having LLC or Inc. after your business’s name conveys maturity in your business to customers and vendors.
- Accessing credit and/or capital. Incorporating can also make it easier for your business to obtain financing through banks or investors. Banks want to see that your business is legitimate and not simply a hobby. Bringing in investors also requires a business form that allows you to do this. Individuals often co-mingle personal funds with business activity, making it hard to consider lending money.
What you need to do
There are several different business entities to consider, including corporations and limited liability companies. There are pros and cons to each entity that must be considered. Added to the complexity are constructing the correct legal filings and related tax obligations for sales tax, income taxes, unemployment and workers’ compensation.
The process of selecting the right structure for your business is not for the faint of heart. Develop connections with professionals that can walk you through this decision-making process.