Hopefully, your business is operating in a formal business structure like an LLC (limited liability company), S Corporation or C Corporation from day one. If not, making the change to a formal business structure needs to go to the top of your to-do list.
A formal business structure is one that you create by filing documents with your Secretary of State. Corporations, Limited Liability Companies (LLCs), and Limited Partnerships are all examples of formal business structures. Trade names, sole proprietorships, general partnerships, and Schedule Cs are all examples of informal businesses.
Informal businesses are cheaper to run. You don’t need to keep separate records, or a separate bank account. The business income and expenses are reported on your personal tax return, so the business doesn’t need its own tax return. The only problem with these businesses is liability. The liability is unlimited, and it’s all falling on you. Your business can’t pay its bills? No problem. You can. Your business gets sued? You get sued, too. Don’t have the money to pay? No problem. Your creditors will settle for your house, car, savings account, and so on. (Yikes!)
Unincorporated Businesses: All of the Risk. None of the Reward.
Informal businesses are bad from a tax angle, too. You lose all kinds of tax reduction opportunities, including the ability to stream income. That alone can cause you to pay thousands of extra dollars in tax.
But it can get worse. You could go into an informal business with one or more partners. Now you have all of the negatives we’ve already mentioned, multiplied by the number of other people you’re in business with. This type of informal business is called a general partnership, and it’s probably the worst choice of all. It only takes one partner to bind a business. So your partner(s) can put you on the hook and risk your personal assets without you knowing anything about it. Until, the lawsuits start flying.
If you really want to have an unincorporated, informal business, then there are only two times we would recommend it;
- If there is very little risk from the business, and/or
- You don’t have anything to lose.
If that’s not true for you, then get incorporated ASAP!