Choices Of Business Setup

[Updated 11/23/08 with more info about LLC]

A reader has asked me how the business of Project BKO is set up. Good question. There are obviously several choices here in terms of business setup. Which one best suits Project BKO? Let's understand what each form of organization means:

Sole proprietarship
This is the most simplest and easiest form of a business, because the business is operated by one person - the business owner. Generally speaking, everyone can be qualified as a sole proprietor and start his or her own business immediately. The owner can choose to register the business under a different name, but many of sole proprietor simply has the business operated under his or her exact legal name. The owner is responsible for paying tax of the business, which can be done in Schedule C of his or her personal tax filing. The owner pays self-employment taxes (Schedule SE) including Social Security and Medicare taxes.

Although convenient, the downside of sole proprietorship is that the owner is legally bound to and held liable for his or her business. There is no legal protection of the business owner against the potential lawsuits against the business in this form of business organization.

Partnership
This form of business organization extends sole proprietorship to include business partners. Since business partners are independent legal entities, their roles and responsibilities should be written down and agreed upon. In addition, the structure of business ownership and financial responsibility must also be discussed and agreed upon to avoid future disputes. For tax purpose, each partner reports his or her profits or losses from the partnership in the personal tax return. The distribution of profits and losses can be flexibly determined and agreed upon by partners.

Limited Liability Company (LLC)
LLC allows you to bring in the investors as your business partners. There is no limit on the number of partners. Tax wise, LLC is very much the same as partnership. More importantly, LLC provides the business owner and partners legal protection of a corporation. That is, they are not personally liable to the actions taken by the corporation.

Incorporation
Incorporation is the most complex corporation structure that I have not done enough research at the moment.

Project BKO as a sole proprietorship
I choose sole proprietorship for its simplicity, since Project BKO is still at its infancy. I'm also not considering hiring any employees other than my two kids for the time being, so I don't have to worry about payroll taxes (e.g. social security and medicare taxes). In fact, hiring your kids of 18 years old and younger as employees has some tax benefits, because they are at a much lower tax bracket. On the other hand, I'm very interested in LLC for the benefits of legal protection, if the project goes well and my businesses grow. In any case, a business is not stuck with its initial form, and can evolve into a different form according to its needs.

There are companies that provide online filing services for registering your business with state and local government, if you decide to do it yourself. Read the hub written by Glass Visage for comparison of some popular products and services.

As a disclaimer, this post serves as my personal understanding. You should definitely discuss with your business consultant or tax adviser for your business.