There are advantages in choosing the best type of business suited to how a business owner wants to operate his or her small business.
It’s vital that the advantages and responsibilities in deciding on the type of business structure are clearly understood and defined as they affect protection of the business, operating costs, the way taxes applies, and how other businesses relate.
1. Sole Proprietorship
The sole trader controls and manages all aspects of the business although he or she may hire employees.
Advantages of Sole Traders
- The structure is inexpensive to set up.
- The proprietor retains full control of the business.
- The proprietor retains full benefit of profits made by the business.
- Few legal and tax formalities are involved in setting up the business.
- If the business is later sold, the owner keeps the after-tax gains.
Considerations
- Business owner is legally responsible for all aspects of the business.
- Debts and losses cannot be shared.
- Access to finances is limited to the owner's own resources.
- Not hiring any employees means the small business owner does all the work.
- Private assets can be lost such as home, contents, and vehicles if the business goes into debt.
- Business owner reports the business income earned after expenses on his or her personal income tax return, along with other income earned.
- Business owner is responsible for his or her own superannuation arrangements, and for making contributions for any eligible employees employed, if applicable.
2. Partnership
In a partnership, business is carried out with one or more other people as partners and income is received jointly.
Advantages of Partnership
- Partnerships are inexpensive to set up.
- Access is greater to finances from the resources of all partners.
- More people share the work load.
- More people share losses and legal responsibilities.
Considerations
- Profits are equally shared with other partners.
- Partners are equally responsible for the debts of the partnership, even if one of the partners does not directly incur the debt.
- Private assets can be lost such as home, contents, and vehicles to settle the debts of the partnership.
- An annual partnership income tax is lodged on behalf of the business showing the total income earned and deductions claimed by the business, although the business does not pay tax. But as a partner, tax need to be paid on the partnership share of income less expenses earned.
- A partner is responsible for his/her own superannuation arrangements being a partner, and partners are responsible for their employees, if applicable.
3. Company
In an incorporated company, the business is a distinct legal entity regulated by the government’s Securities and Investment Commission. Operating a company is more complex compared to the structures of a sole trader and partnership. The set-up and administrative costs are higher in companies.
Advantages of Companies
- Companies have greater access to capital for the running of the business.
- A company pays tax on its own profits.
- Shareholders are not liable for the debts of the business.
- Asset protection is higher.
Considerations
- Companies are more expensive to establish.
- Tax reporting requirements are far greater than for sole traders and partnerships.
- Shareholders have little say in the running of the business.
- Companies pay their own annual income tax return to report income and deductions.
- Companies make super contributions for any eligible employees, including a company director.
4. Trust
In a business operated as a trust, the business owner is called a trustee and is responsible for holding property or income for the benefit of others referred to as the beneficiaries.
Advantages of a Trust
- A trust has a limited liability if the trust is a company.
- A trust has perpetual existence and does not cease with the death of the beneficiary.
- Increased asset protection.
Considerations
- Trust is more expensive and could be complicated to set up like a company.
- More expensive to complete the required annual tax and administrative paperwork.
- Profits distributed to children under 18 may be taxed at higher rates.
- A trustee can use discretion each year to decide which beneficiaries will receive income. Trusts can pay high rates of tax on any profits that are not distributed.
The content in this article is for information only. A business adviser, tax professional, or other business consultant who can provide the proper advice should be consulted before deciding which business structure to use.
Interested readers may want to check out the following articles:The Value of Time Planning of Small Business, Learn about Small Business and Own One, Characteristics of Successful Business Owners, Business Planning Important to Small Business and Business Plan Outline and Guidelines.
Sources:
www.entrepreneur.com/startingabusiness
www.irs.gov/businesses/small/article
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