While it may sound or even look confusing when you first start looking into different legal organizations for your business, the difference between the different types are actually quite simple. There are three basic legal forms available: sole proprietorship, partnership, and corporation. There is also a hybrid version available called an LLC which we will also discuss. The choice between these legal forms lies in the taxation and liability differences that each individually offers. By using the analysis below, you will be better informed when discussing or using any of these legal forms for your massage therapy practice.
1. Sole Proprietorship
A sole proprietorship is created by one owner and this owner has the advantage of being taxed at her personal income level. There are no individual business taxes or distribution taxes to the owner. In this type of legal form the owner is the business and visa vie. The other main advantage to the sole proprietorship is its ease to establish, there is no need to register with the state or federal government for the business to exist. As long as you are the sole owner there is no need to register at all because you are the business. There are no major hoops to jump through and depending on your location you may not even have to register the business locally. This all sounds wonderful with the ease of establishment and the lack of intense regulation*, but these advantages come at a cost. This cost comes in the form of liability. Due to the fact that a sole proprietorship is only established through one person, there is no separation between the business and the business owner therefore the debts and liabilities of the practice are equal to those of the practice owner.
Sole Proprietorship Example: Suzy opens a massage therapy practice under a sole proprietorship. She makes $50,000 a year and this $50,000 is taxed at her personal income level. While she did not have to register her business with the state or federal government, she is completely liable for her business. If someone were to sue Suzy’s business or for some reason her business could not pay the mortgage on her new spa, Suzy would personally take on these debts even if the business were to fail.
A partnership is just what you would imagine it to be; two or more people starting a business together. However, there are some things that aren’t as obvious. The first is that partnerships have unlimited liability just like we discussed for sole proprietorships. The difference is that you are now responsible for the actions of your partner(s) also. If your partner decides to take out a loan for the business, then you are now responsible for that loan also. Worse, because this is a basic partnership, if the business cannot pay back the loan you would have to pay back the loan with personal, non business related assets. This is a horrible situation and one that can be eliminated by choosing alternative legal forms. If you are interested in a partnership, but want more liability protection consider looking into an LLP (limited liability partnership) or an LLC with multiple members depending on the business situation. The advantage to the partnership legal form is that it does offer the pass through of business income to the personal level. There is no double taxation and any money the business makes will automatically be taxed at you and your partner’s individual personal income level.
A corporation is a separate entity than the actual business owner(s). A corporation can buy real estate, open bank accounts, be sued and sue. The advantage of this is that the business owner or stockholder can own a company by owning stock without the liability problems of sole proprietorships or partnerships. If someone sues the corporation you own, you can only loose what you have invested in the corporation, not anything more. Since corporations are separate entities, they can last forever and do not depend on the life of the individual owner. The main disadvantage to the corporation legal form is the idea of double taxation. Being a separate entity, the corporation is taxed on business income first and then when the owner pulls money out of the business that money is taxed again at the personal level. Because of the complexity of this legal form and double taxation, it is not a top choice for small business owners and entrepreneurs.
Essentially, the LLC is the hybrid legal form created to give the benefits that entrepreneurs are looking for without the added costs. The idea that a corporation can be a separate entity giving the owner liability protection is a huge selling point for that legal form, however the sole proprietorship and partnership offer the benefit of business income passing through to the personal level with no specific business tax. Because of the differences in these legal forms, the LLC or limited liability company was created to give business owners exactly what they were looking for. Registering your business with your state as an LLC gives you the liability protection that a corporation would provide (LLCs are separate entities), allows business income to be taxed on a personal level, and an easy registration process. The ease and low costs (~$100-$200 depending on the state) along with the perfect mixture of liability protection and taxation makes the LLC the best choice for massage practice owners and entrepreneurs.
*As a side note, limited liability and low regulation does not mean that you do not have to comply with individual state and local massage therapy regulations. It also does not mean that you should not have insurance. Even with limited liability, you still want to protect the business entity.