Choosing the Right Business Structure

Q: After 23 years as a professional working for others, I have decided to start my own business from home. Should I be a sole proprietor or incorporate as an LLC?

A: Generally speaking, the purpose of setting up any kind of corporation is to shield yourself from liability and protect your assets from creditors. If you're planning to give your clients advice, publish articles written by others, manufacture products or engage in any other kind of business that might get you entangled in a lawsuit, you should definitely consider incorporating your business. Other advantages to incorporation include the ability to raise capital by selling stock, the ability to transfer ownership to heirs or investors quickly and easily, and greater flexibility in setting up retirement funds and qualified retirement plans, like a 401(k).

The downside is that you'll need to lay out money to set up your corporation, keep careful records of shareholders' meetings and file a separate tax return. You will also be taxed twice on your company's profits unless you elect to become an S corporation or set up your corporation as an LLC.

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Remember: You can always start your business as a sole proprietorship, then incorporate your business later as your company's needs change. Here is a brief overview of the differences between the various types of corporations:

• Sole proprietorship: There's no cost to set up a sole proprietorship, no legal forms to fill out and no government hoops to jump through. You can open or close the business at any time, and you'll retain full control of the company's operations. Any profits that you earn will simply appear on your personal tax return as Schedule C income. The downside is that you may be exposed to liability arising from a faulty product or shoddy service, and an adverse legal judgment could wipe out everything you've got. Raising capital and transferring ownership will also be difficult as a sole proprietor.
• LLC: This is less formal and less expensive to set up than a corporation but still offers liability protection to the company's members. Profits and losses are passed through to the LLC's members on their individual tax returns, and, unlike a corporation, there is no need to file a separate business return. LLCs also allow their members to sell shares to raise capital and transfer ownership interests.
• S corporation: Probably the most common type of small-business corporation, an S corp. protects its shareholders from the debts of the corporation and is managed by a board of directors elected by the shareholders (who are often the company's owners and officers). The big advantage of an S corp. over a regular corporation (C corp.) is that the profits (or losses) pass through to the shareholders directly instead of being taxed twice as corporate dividends and then as personal income. Like a C corp., shareholders of an S corp. can raise money and sell shares without a problem. The only downside is that the number of shareholders is limited to 75--a potential problem if your company takes off and you decide to raise money through a public offering. To become an S corp., you must first file with the state in which you are incorporating your business, then complete IRS Form 2553 to elect S corp. status.
• C corporation: A C corp. is similar to an S corp. except in two respects: The corporation is a taxable entity, and the company's losses cannot be deducted by its shareholders. That's why C corporations are often larger companies with thousands of shareholders--in many cases, publicly traded corporations. C corporations can also be an attractive option for business owners who intend to pay themselves low salaries and reinvest most of the profits in the company.

For an excellent overview of the pros and cons of the various types of corporate structures, you can check out the Business Filings Web site.

Depending on which attorney you choose, you can spend anywhere from a few hundred to a few thousand dollars in legal fees to set up your corporation. While I strongly recommend consulting an attorney before setting up your corporation, many entrepreneurs prefer to save money by doing it themselves. Sites like Business Filings and MyCorporation.com let you create your own corporation by filling out an online form. The cost to use these services is $99 to $310, plus the applicable state filing fees.

Rosalind Resnick is the founder and CEO of Axxess Business Centers Inc., a storefront consulting firm for start-ups and small businesses. She is a former business and computer journalist who built her Internet marketing company, NetCreations Inc., from a two-person homebased start-up to a public company that generated $58 million in annual sales.

The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.