The Right Legal Structure for Your Business

There are many variables to choosing the right business entity, but a good place to start is to prioritize liability issues over tax issues

Q: I'm trying to start an independent record label, and I'm also a piano accompanist. I'd like to combine both those services under one company, but I'm still deciding whether to classify my business as a sole proprietorship or a corporation. Would a corporation provide me with more tax advantages if I earn under a certain amount of income? If I'm more successful in subsequent years, would it be hard to change the legal structure? —E.F., Miami

A: This is a common sticking point for entrepreneurs getting started and there are many factors that go into making the decision. The legal technicalities are complex and the pros and cons can be confusing. You're best off if you can meet with an attorney who specializes in small business and get advice tailored to your specific situation.

That said, do not let your decision be driven by tax issues, says CPA Jeffrey H. Greene of Hollywood, Fla. "Tax advantages are one piece of the information that you utilize to make the decision. But more important is the question of whether you need to limit your liability. If so, you'll want to form an S-Corp or an LLC," he says. "These days, in almost anything you do, I'd have concerns about limiting liability."

But not all experts worry so much about liability. In fact, most service businesses that do not have significant liability concerns start off as sole proprietorships, says Bob Schroeder, a CPA based in Palm Coast, Fla. Another choice you might ask an attorney about is a single-member LLC (limited liability company), which provides a degree of liability protection under Florida law, he says. "As a musician or recording business, your liability is probably very small. The main reason for incorporating is if you have employees who could be injured while working for your company," he says.

If you don't plan to hire employees immediately, consider starting off as a sole proprietor or as a single-member LLC and then reevaluating your legal structure as you become profitable and begin to make hires. Both those entities are cheaper to start and simpler to operate than corporations, which must file separate tax returns annually. "Whenever you have to file an additional return, the lawyers and the accountants are there lining up for their money. Start off simply, and if your company becomes successful and you get employees, then you can revisit the choice and make your firm into a more sophisticated type of operation," advises Schroeder.

Another question to raise with a knowledgeable attorney is whether you should combine both your ambitions under one business banner, Greene says. "It might be better to form separate entities for each business. One is a professional performer and the other works in the business side of the music industry, so they're not so much related."

The IRS has excellent information on the various business entities along with the pros and cons of each for small business startups.

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