When you first open a retail store, there’s a lot to do. Finding your space, designing your store, ordering inventory…but before you do any of that, you have to register your new retail business.
In the U.S., there are five main business structures recognized by the Internal Revenue Service (IRS):
- Sole proprietorship,
- Partnership,
- Limited Liability Company (LLC),
- Corporation, and
- Cooperative.
The structure you choose affects more than just the legal paperwork you file for your business — like how the government taxes your business income and the regulations about business organization you have to follow. That’s why it’s important to weigh your options and ensure you select the best structure for your business.
We’ll take a look at what each of the three most common entities means for your business, the pros and cons of each, to help you make the best choice for your new retail business.
Common Retail Legal Structures
As discussed, there are more than three legal structures recognized in the U.S., but we’ll focus on the three most common choices for retail businesses: LLC, corporation, and sole proprietorship.
Within each of these broad categories, there are more options to choose from — like S corporations and limited liability partnerships.
Let’s dive into what each option means for your business and your taxes.
Sole Proprietorship
A sole proprietorship is the most basic form a business entity can take. Essentially, it means you’re doing business as an individual — registering as a sole proprietorship doesn’t create a separate entity for your business. And if you don’t register as another type of business, you’re automatically a sole proprietor.
Tax Structure
As a sole proprietor, your business revenue represents a part of your own personal income, and it’s taxed that way as “pass-through income.” That means you claim business earnings on your personal income tax return and don’t file separately as a business entity. On top of the standard income tax, you’re also responsible for the employer part, covered by an extra self-employment tax.
Benefits of Sole Proprietorship
- No corporate tax
- Unlimited flexibility to run your retail business however you see fit
- All profits pass through to you, the owner
Disadvantages
- Personal liability: if your retail business faces a lawsuit, defaults on a loan, or declares bankruptcy, all your personal assets (including your house and your car) are exposed
- You’ll have to pay self-employment tax
- It can be hard to raise outside funding. Sole proprietors can’t sell stock and banks may be hesitant to give out loans
Best Suited For:
A sole proprietorship isn’t a great choice for most retail businesses. Instead, we recommend choosing from one of the legal structures that protects you from personal liability.
Limited Liability Company
A limited liability company (LLC) separates your personal assets from your retail business’ assets — when it comes to liability, at least. Forming an LLC protects your personal assets (like your house and car) from being seized in the event your business faces a lawsuit or files for bankruptcy.
Tax Structure
As a limited liability company, you’ll pay taxes in the same way a sole proprietor does. The IRS considers your business revenue “pass-through income” — it passes through your business and right onto your personal income tax. You won’t pay any additional corporate taxes, but just like a sole proprietorship, you’re responsible for the employer part of social security and Medicare tax. That’s where your self-employment tax comes in.
Benefits of LLCs
- Your personal assets are protected from most or all business liability
- Pass-through taxation
- Simple and affordable to form. LLCs also aren’t held to any rigid operating or reporting standards
Disadvantages
- LLCs members cannot pay themselves wages. Owners receive profits and must pay self-employment tax
- Most states require LLCs be dissolved and reformed should one or more owners leave
- Profits are taxed as pass-through income at the federal level, but many states impose an extra franchise or capital values tax on LLC profits
Best Suited For:
LLCs work best for small- to medium-sized retail businesses. If you aren’t planning to expand substantially or offer stock, an LLC is a great option to protect yourself from personal liability and keep your tax burden lower, without jumping through all the hoops involved with incorporation.
How to Form an LLC
Registering as a limited liability company is a lot easier than forming a corporation, but there are still a few steps you have to take:
- Choose an available name (use a tool like the National Business Register or LegalZoom to see if your preferred name is available)
- File the formal paperwork (your Articles of Organization) and pay the filing fee, which varies from state to state
- Create an LLC operating agreement by outlining the roles and responsibilities of each member of the company
For more help with any of the steps, check out Nolo’s guide to forming an LLC or work with a lawyer in your state.
Corporation
A corporation (sometimes called a C corp) is the most formal way to structure your business. When you incorporate a business, it becomes a separate entity in the eyes of the IRS — your business becomes its own thing. You’re 100% protected from personal liability as an individual, but establishing and running a corporation means you have to follow strict operating and reporting procedures.
Tax Structure
When you register your retail business as a corporation, your business becomes its own entity, separate and apart from you. As such, a corporation files its own taxes, separate and in addition to your personal income tax. Corporations pay a flat rate of 21% (as of 2018) toward federal taxes on all corporate profits. Any wages or dividends you collect from the corporation are subject to your personal income tax, but you won’t pay self-employment tax.
Benefits of a Corporation
- All owners are 100% protected from personal liability
- As its own, separate entity, a corporation can live on and transcend owners
- It’s easier to raise capital through investors, banks, or going public
Disadvantages
- Forming a corporation is expensive, time-consuming, and requires a lot of paperwork
- Your management, operating, and reporting procedures are heavily regulated — limiting your flexibility as a small retail business
- Double taxation. Corporate profits are taxed through the corporation and then a second time, in the form of wages or dividends, on your personal income tax
Other Options
S corporation: If your business meets certain restrictions, you can file to become an S corporation (S corp). S corps must have fewer than 100 shareholders who are all U.S. citizens and register with the federal government, in addition to your state. You still have to follow the rigid corporate operating procedures, but if you qualify for S corp status, you can pay taxes as a pass-through entity — avoiding the corporate tax rate.
B corporation: A benefit corporation (or B Corp) is another type of corporation for businesses that operate for both mission and profit. There aren’t any tax benefits to registering as a B Corp, but if your retail business is dedicated to purpose, accountability, and transparency, you can register as a B Corp.
Best Suited For:
If your retail business has aspirations of substantial growth, franchising, licensing, or raising outside capital, incorporating is the best way to go. Additionally, if you qualify for S corp status, a corporation is a good option.
How to Form a Corporation
- Choose an available name for your business
- Appoint directors for your new corporation
- File your Articles of Incorporation and pay the filing fee
- Write your corporate by-laws, outlining the operating procedures and rules for your business
- Hold an initial board of directors meeting
- Issue stock certificates to all shareholders
If you’re looking for more detail on these steps, see Nolo’s guide on How to Form a Corporation. Given the complexity and cost of incorporating, we recommend working with an attorney, too, to help you through the process.
The Best Legal Structure for Your Retail Business
Choosing the right legal structure is a vital part of establishing your new retail business. Your business’ structure determines how (and how much) you pay taxes, your personal liability in the event of legal issues or debts, and a whole host of other important factors. So, ensure you’re choosing the right legal structure for your retail business.