We often hear that thinking about taxes feels like one of the most daunting parts of owning a business. If you’re just starting out, you may hear advice about starting an LLC or picking the right tax structure for your business. Let’s get into what that means, and how to go about considering which one is right for you.
There’s no one-size-fits-all solution or piece of advice we can give. With a little research and the right guidance, you can choose a legal structure that provides the right balance of liability protection, tax advantages, and administrative requirements to support your food business goals.
Sole Proprietorship
One of the easiest and most inexpensive routes is a sole proprietorship. As the sole owner, you have complete control over the business, but you’re also personally liable for any debts or legal issues that arise. This makes sole proprietorships a good fit for small, lower-risk food businesses with limited assets*. You can usually register your business easily and cheaply but this varies from state to state, just look up “Sole Proprietorship + STATE” to get started.
Partnerships
Another option is a partnership, which comes in two main forms – general and limited. With a partnership, the profits and losses “pass through” to the individual partners’ tax returns. The downside is that each partner shares personal liability for the business’s obligations. Think of this almost like two Sole Proprietors running a business.
S and C Corporations
Forming a corporation creates a separate legal entity, protecting the owners/shareholders from personal liability. This added protection comes at a cost – corporations are more complex to set up and require a lot more administrative work every year.
There are two main types of corporations – C corporations and S corporations.
C corporations are the standard, traditional corporation structure. They are taxed as their own entity, paying corporate income tax on their profits. Shareholders then pay personal income tax on any dividends received from the corporation.
S corporations, on the other hand, are considered “pass-through” entities. Instead of the corporation paying income taxes, profits and losses are reported on the individual owners’/shareholders’ personal tax returns. S corps face more restrictions, such as a cap on the number of shareholders. Even still, many food businesses opt for S corp structure.
Starting a corporation, whether a C corp or S corp, typically requires working with a lawyer. The process involves filing articles of incorporation*, establishing a board of directors, issuing stock, and complying with various state and federal regulations. Corporations must also maintain detailed financial records and file annual reports.
The upside of this extra effort is that a corporation protects the personal assets of its owners. If the business faces legal issues or financial troubles, the corporation is liable, not the individual. This makes corporations a smart choice for food businesses with big investments in equipment, facilities, or that face high liability risks.
Limited Liability Companies (LLCs)
The Limited Liability Company (LLC) has become a popular choice, because it combines advantages of both partnerships and corporations. LLCs allow profits/losses to pass through to owners’ individual tax returns, while also providing owners with limited personal liability. Many food businesses opt to form an LLC, though a drawback here is that many states charge an expensive annual registration fee that you may not want to take on too early in your business journey.
Cooperative Ownership
While this structure is more rare, it may be worth considering for food businesses with a more collaborative, community-focused model. These are owned and operated collectively by multiple people with a shared mission, and are common in farmer’s markets and grocery stores. While cooperatives can access certain government grants, keeping members engaged can be a challenge.
The bottom line
When evaluating the best legal structure, key factors to consider include liability exposure, tax implications, administrative set up and costs, and future flexibility. Think about your team and your specific needs, consult a lawyer and accountant if you can, and don’t be afraid to start simple and change structures as your business grows.
The most important thing is selecting a legal framework that protects you, minimizes your tax burden, and lays the right foundation for your food business to grow and thrive.
Glossary
Assets – something that a person or business owns that has value. For a food business owner this may be inventory, property, kitchen equipment, cash in the bank.
Articles of Incorporation – Legal documents that establish a corporation and are filed with the state government where the business is located