Choosing the right legal structure when setting up your business is an important, yet intimidating task. It affects your taxes, liability, ownership, and even your business mission and values. In this blog post, we’ll give you an overview of the most common legal structures so you can better understand your options and make an informed decision.
Getting Paid
Before we dive into the different legal business structures, you need to understand how you get paid and whether an owner’s draw or salary will work best for you.
Owner’s Draw
An owner’s draw is money withdrawn from the business for your personal use (i.e. how you get paid).
Pros:
- You can take money out when you need it rather than on a fixed schedule
- You won’t need to set up a payroll system
- You’re not withholding taxes from your draw, though you’ll need to pay them later via self-employment and income taxes
- It’s a good option for seasonal or new businesses that aren’t yet turning a consistent profit
Cons:
- You must track and pay estimated quarterly taxes yourself
- Irregular withdrawals can disrupt the business’s finances
- Without a W-2 income, it may be harder for you to qualify for loans or mortgages
- You forfeit retirement and benefits contributions
Salary
Like the paychecks you received before starting your business, an owner’s salary is a regular, fixed payment paid to yourself as an employee of the business.
Pros:
- You receive predictable income
- Your taxes are automatically withheld
- It shows credibility to investors and lenders
- You are eligible to receive employee benefits like retirement and health insurance
Cons:
- It requires payroll setup and ongoing admin work
- Your business must pay employer-side taxes like Social Security and Medicare
- Once you set your salary, you need to stick to it or undergo a formal process to change it
- You must pay yourself a reasonable salary based on industry standards
Sole Proprietorship
A sole proprietorship is ideal for low-risk businesses and entrepreneurs who want to test their business ideas before forming a more formal business.
Pros:
- Setting up your business is easy
- There are no formation documents
- State registration is only required in NH for a DBA (doing business as)
- You are only required to file with the federal government for an EIN if you have employees besides yourself
- No annual reporting requirements
- Easy to file along with your personal income taxes
Cons:
- Personal liability
Pay Structure: Owner’s Draw
Partnerships
A partnership is best for businesses with multiple owners, professional groups (like attorneys), and groups who want to test their business idea before forming a more formal business.
Pros:
- Setting up your business is easy
- Partnership agreement is required
- State registration is only required in NH for a DBA (doing business as)
- We recommend filing with the federal government for an EIN, but partners may use their SSNs
- No annual reporting requirements
- Easy to file along with your personal income taxes
Cons:
- Personal liability
Pay Structure: Partner’s Draw (similar to an owner’s draw, but divided among multiple owners)
Limited Liability Company (LLC)
An LLC is best for medium- or high-risk businesses, owners with significant personal assets they want to protect, and owners who want to pay a lower federal tax rate than they would with a corporation.
Pros:
- Setting up your business is still fairly easy
- Certificate of Formation is required
- State registration is required in NH
- You must file with the federal government for an EIN
- Easy to file along with your personal income taxes
- Business liability protects your personal assets
Cons:
- You must complete annual reports
Pay Structure: Salary and/or Profit Distribution
Corporation (C-Corp)
A C-corp is best for medium- or high-risk businesses, those that need to raise money, and businesses that plan to “go public” or eventually be sold.
Pros:
- Business liability protects your personal assets
- Gives your business credibility
Cons:
- You must file corporate taxes (unless registered as an S-Corp)
- You must complete annual reports
- Setting up your business is slightly more difficult
- Required Articles of Incorporation and Bylaws
- State registration is required in NH
- You must file with the federal government for an EIN
- You must set up and fill a board of directors
Pay Structure: Salary and/or Profit Distribution
Benefit Corporation
A Benefit Corporation is best for medium- or high-risk businesses, those that need to raise money, plan to “go public” or eventually be sold, and those who want to operate as a “triple bottom line” business (meaning you emphasize not only profit, but also social and environmental impact). It’s important to note that this is not the same as a certified B Corp. Learn more about the difference.
Pros:
- Business liability protects your personal assets
- Gives your business credibility
Cons:
- You must file corporate taxes (unless registered as an S-Corp)
- You must complete both corporate and benefit reports annually
- Setting up your business is slightly more difficult
- Required Articles of Incorporation and Bylaws specifying the “benefit” components of the business
- State registration is required in NH
- You must file with the federal government for an EIN
- You must set up and fill a board of directors
Pay Structure: Salary and/or Profit Distribution
Nonprofit Corporation
A nonprofit organization is best for enterprises and endeavors organized to do charity, education, religious, literary, or scientific work and primarily funded through donations and grants.
Pros:
- Organizational liability protects your personal assets
- No income or profits taxes, but you must file federal nonprofit tax returns
- Makes you eligible for grant and other funding opportunities
- Gives your organization credibility
Cons:
- You must file corporate taxes (unless registered as an S-Corp)
- You must complete reports annually and corporate reports every five years (in the state of NH)
- This structure is the most difficult to set up
- Required Articles of Incorporation and Bylaws
- State registration is required in NH with both the Secretary of State and Charitable Trusts
- You must file with both the state and federal governments for tax-exempt status
- You must set up and fill a board of directors
Pay Structure: Salary if employed by the nonprofit. Nonprofits are not “owned”. They are governed by a founder or executive director and board of directors.
Final Tips for Setting Up Your Business
There’s no one-size-fits-all structure for setting up your business. When deciding which legal structure to go with, be sure to consider your goals and mission (should you set up a for-profit at all?), liability tolerance, funding needs, and commitment level. If you’re just testing the waters, a sole proprietorship should work fine. If you want something more formal that will protect your personal assets, consider an LLC or corporation structure.
Don’t hesitate to reach out to a professional. You can meet with a legal coach through the Hannah Grimes coaching roster up to three times for free.
