How to Write a Business Plan, Part 4 – Choosing the Right Legal Structure
If you’ve been following our six-part series about writing a business plan, you’ve read about what’s involved in starting a business, what’s involved in creating a sales and marketing platform for your new business, and understanding your business finances. In this post we’re going to focus on the different types of business organization you can choose from when you’re writing a business plan for your new business.
Do You Have to Incorporate?
A lot of new business owners think that you have to incorporate as part of starting your own business, but that is not the case. There are a couple of different ways that you can set up an unincorporated business.
When you incorporate your business, you’re creating a separate legal entity for your business, one that is separate from you as a personal entity. With an incorporated business, you have to remit tax returns just like you have to as an individual.
Because an incorporated business is a separate legal entity it does provide the owners some protections that an unincorporated business doesn't. As an unincorporated business owner, you are personally liable for the activities of your business, so if your business is sued then your personal property can be used to settle any judgments against your business.
That isn’t to say that if you do incorporate you can get off scot-free. As an owner and an officer of a corporation you can be held personally liable for your business even if you do incorporate. Even with things like getting a loan for your business – banks will probably require that someone guarantee a business loan with their personal assets so if the business can’t repay the loan the bank can seize the guarantor’s personal assets to settle the debt.
Types of Unincorporated Business
If incorporating your business isn’t right for you, you can choose to remain unincorporated.
The simplest form of being an unincorporated business is to be a self-employed professional. You pay personal income tax on any leftover income you earn after your business expenses are paid. If you work as a self-employed professional then you do not need to register a business name, you simply operate your business under your personal name.
The next type of unincorporated business you can operate as is a sole proprietorship, where you can register a business name but essentially you’re still claiming the revenues and expenses of the business against your personal income taxes.
A partnership operates similar to a sole proprietorship but with more than one individual. The income and expenses of the business are counted as part of the personal income taxes of the partners.
When is the Right Time to Incorporate?
There are a number of things to think about in choosing the right time to incorporate your business, but one of the key factors is your tax situation.
Personal income taxes are scaled based on your income level, so as you earn more money you get taxed at a higher rate. If you’re in the early stages of your business and you’re not earning a lot of money, it might be worth operating as an unincorporated business and paying the lower personal income tax rates. Once your business grows and starts making a profit then taking advantage of the lower corporate income tax right is probably more effective.
But it’s not as easy as choosing the lower tax rate. Even if you incorporate to take advantage of the lower corporate tax rate, you still have to get leftover profits out of the corporation, subjecting them to personal income taxes. However, there are ways that an owner can take money out of a company apart from through payroll such as bonuses and dividends, but likewise each of these have their own tax rates.
All in all, there are a few things that you have to think about when deciding whether or not to incorporate, and this is where a professional bookkeeper can deliver a lot of value. A knowledgeable and experienced bookkeeper can help find the best way for an owner to get paid while paying the least amount of tax possible, and this includes choosing the right legal structure for the business.
When you’re writing your business plan, you should consider which legal structure your new business will have and take the appropriate tax impact into your financial calculations. If you run choose to operate as an unincorporated business then profit that your business earns is counted against your personal income taxes, whereas if you choose to incorporate then your profits are subject to corporate income taxes before they can be taken out of the business. Hiring a bookkeeper to help you determine the best legal structure is a worthwhile way to make the best choice.
Check back for the fifth installment of this six part series where we’ll discuss the different professionals you’ll want to get help from as part of writing your business plan.
Simply Bookkeeping1 provides professional bookkeeping services for freelancers, solopreneurs and owners of unincorporated and incorporated businesses. We customize our services based on your needs – we only see some of our clients a few hours a month but others we see on a more regular basis. Our services are reasonably priced and we tightly track the amount of time we spend working for you so you only pay for the services you get.
To learn more about us, please visit our website at www.simplybookkeeping1.com or contact Michele Hyde by phone at (647) 668 – 9363 or by email at firstname.lastname@example.org.
Have Your Say
Are you trying to decide which legal structure is right for your new business? If so, we’d love to hear from you! Tell us what you’re thinking about and which way you’re leaning. Also, please share this article using the social media share buttons – other people also writing a business plan might benefit from your thought process!