When it comes to business structures there are three types: the good, the bad and the really bad. Now before you think this article has nothing to do with you, consider this.

If you receive a Form 1099-MISC, or called an independent contractor, you have a business. And when it comes to selecting the right business structure, it doesn't matter how big your business is, it matters how much you have to lose if something goes wrong. The more wealth you have, or the more wealth you plan to have, the more important selecting the right structure becomes.

Before we go into more detail on those structures, let me start with a story that was told to me by an attorney friend. When he talks to people at his sell-out seminars, the one thing he always emphasizes is protecting your assets. Face it -- why go to all the trouble of building a business and wealth, if you're not going to work just as hard to keep it?

He talked about the bad business structure, the sole proprietorship. That's the type of business structure you have if you haven't filed as another type of structure for your business. It's the default structure that means you'll pay more in tax, have a 10 times greater risk of an IRS audit and have just put all of your personal assets at risk from some mistake that could happen with your business. My friend talked about the risk of a sole proprietorship and then made the statement that he didn't think anyone should begin a business until they have one of the three good business structures already in place.

After the seminar, a lady came up to him and said that she had just started her business and although she now understood the importance of a business structure, just didn't have the time or money to form something now. My friend strongly suggested she wait to do anything in her business until she did have the time and money to protect her other assets with a good business structure. She promised to call him in 3 months. So, he was happy when she called him in 2 months. That is, he was happy until he knew why she had called him. Something had gone wrong, and although her employee was the one who caused the damages to a customer's property, he was in her employment at the time and that meant she was liable. What could she do now to protect her home, her savings account and her investments? "Nothing, absolutely nothing," replied my friend.

The time to protect your assets is before the problem occurs. If you wait until after there's a problem, there is nothing you can do.

Good business structures include: Limited liability company (LLC), S Corporation and C Corporation.

These structures will protect your personal assets from litigation that might come about from your business. Of course, the business may still be at risk if there is a suit. But, at least you won't lose your house too. The S Corporation and C Corporation business structures also will affect how you pay taxes.

Generally, real estate agents do best with an S Corporation structure. That's because it is the easiest to run. You'll have to file a separate tax return at the end of the year, but the income all flows to your personal return so there is no tax due at the corporate level. The LLC elects how it wants to be taxed. If you don't elect a method (generally as an S Corporation or a C Corporation), you will default to either the Sole Proprietorship structure for taxes if you're the only owner or the partnership structure for taxes if you have a partner.

Now, let's look at the really bad business structure -- the general partnership. If you're a general partnership, you are not only liable for all the crazy things that you might do, you're also liable for all the crazy decisions your partner might make. You've cut your profits in half and doubled your risk. Most attorneys won't put your business into a general partnership simply because the risk for their clients is too great. But, here's the problem and it's a doozy. If you go into business with your friends through an informal handshake deal or with a more formal joint venture, you're a general partnership unless you form another type of business structure.

The right business structure can save you taxes and save your assets in case of a lawsuit. The extra cost associated with having a business structure is easily offset by the tax savings and peace of mind you'll gain.

Published: July 12, 2006

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Diane Kennedy, the nation's pre-eminent tax strategist, is owner of Diane Kennedy & Associates, a leading tax strategy and accounting firm and founder of TaxLoopholes. She is the author of The Wall Street Journal and Business Week bestsellers, Loopholes of the Rich and Real Estate Loopholes, and co-author of The Insider's Guide to Real Estate Investing Loopholes, The Insider's Guide to Making Money in Real Estate, and TaxLoopholes for eBay Sellers. Register for free Tax Strategy updates and e-Newsletters delivered via email from TaxLoopholes.com. You will be updated on current tax law changes as well as proactive tax strategies the wealthy use plus news regarding Diane Kennedy.