Choose the most advantageous business type

Q. I'm being given a severance package as part of a corporate merger and think this is the perfect time to try my hand with a small business venture I've always dreamed about. Between the severance and savings (outside of my retirement accounts) I have enough cash on which to live for two years, including the startup costs of my business. My question is which type of business should I have, sole proprietorship, LLC, S-Corporation or C-Corporation? I've been a corporate rat all of my career and don't know which would be best for a small-business owner.

It sounds like you have enough money to meet with a lawyer to finalize your decision on the best way to structure your business, which is what I advise. Some knowledge before you meet with a professional is always beneficial, so the information below about each type of ownership structure should be helpful.

A sole proprietorship is very simple. It doesn't require you to register with the state, and no special papers need to be filed. The biggest problem is that you and your business are seen as one. You don't have any protection from debts, court judgments and any other legal obligations. This means you are personally liable for any actions against your business, and your personal assets can be sought to satisfy any business obligations. Partnerships have the same problems, other than limited partnerships, which usually are not recommended for small businesses because of the complexities and costs of set-up. If personal liability is not a concern, a sole proprietorship may be appropriate.

A limited liability company or a corporation will limit the owner's personal liability to the assets of the business. LLCs and corporations share this protection but differ in the way taxes are paid. Owners of LLCs pay taxes on their shares of the business income on their personal tax returns. Owners of corporations pay taxes on the business income on separate tax returns. Personal taxes are paid only on money drawn from the corporation. Corporations also allow businesses to sell company ownership shares, but if you don't plan to issue stock options or go public, don't let this be a factor in your decision.

LLCs are more flexible and simple than corporations and make a lot of sense if your business is going to hold assets such as real estate that may increase in value. When the property is sold, the LLC members are taxed only once, whereas the gains in a corporation are taxed twice: once at the corporate level, and again for shareholders.

C corporations are of more value if you plan to have multiple investors in your business and you'd like to provide fringe benefits to owners. A C corporation is probably the most complex and costly business structure.

S corporations are taxed a bit differently. You pay Social Security tax on money received as compensation, but you don't pay this additional tax on profits. This may save on taxes versus an LLC, but it requires more formal record keeping.