In the United States, there are 5 basic legal business structures that you can choose from, including a sole proprietorship, a partnership, a limited liability company (LLC), an S corporation, and a C corporation. However, when starting a new restaurant, you will likely choose between only 3 of the below.

For the vast majority of restaurants, we recommend choosing an LLC as it best balances your restaurant’s legal risks with total costs. However, prior to making a decision, we strongly recommend consulting with an accountant and / or lawyer as they may provide advice specifically tailored to your business. In addition, some of these experienced professionals may even offer free consultations. 

When choosing between the legal business structures, it is important to consider the following 6 elements as each structure will have its own advantages and disadvantages.

1. Filing Fee CostsThe cost to register your legal business structure will generally be cheapest for sole proprietorships and partnerships versus LLCs. This is also the case in Maryland. The base filing fee for an LLC is $100. In contrast, there is no filing fee for sole proprietorships and general partnerships, unless you plan to register a trade name (i.e. “Doing Business As”) which would cost $25. Not that additional fees may apply like “expedited fees” or “service fees”.For additional information, you can refer to the Maryland Filing Fee Schedule here.

2. Complexity / TimingSole proprietorships are generally the easiest and quickest way to form and operate your business since they have very few legal requirements. Partnerships are similar, but may have additional complexity depending on partner agreements. On the other hand, LLCs are more complex and time-consuming to register as the application requires more information and processing.

3. Liabilities / RiskSole proprietorships and partnerships generally do not offer any protections against the liabilities your restaurant may have. Thus, you and/or your general partners will have 100% accountability for any debt and legal action related to the restaurant. In other words, you and/or your general partners risk losing personal assets (e.g. your house) if the restaurant, itself, cannot pay those obligations. Beyond this risk, assuming all of your restaurant’s liability can also negatively impact your relationship with customers and employees.As a separate legal business entity, LLCs offer you protections against your restaurant’s potential liabilities. If the LLC has debt or gets sued, you will, in most instances, not be personally liable to the creditors. In an industry where legal action is common and success rates low, obtaining these protections are enough of a reason to choose LLCs.

4. TaxesUnder a sole proprietorship or partnership, you will be required to report your restaurant’s taxes in connection to your personal income. While an LLC is normally taxed similarly, you may have the option to make an IRS election to be taxed as a C corporation or S corporation. This may offer additional tax flexibility and an opportunity to optimize your taxes by taking advantage of lower tax rates.\Note that determining the optimal tax strategy can be a daunting task, especially since there are so many different tax categories. Thus, we strongly recommend consulting a tax attorney or professional to help guide you towards the most optimal tax classification for your LLC.

5. IRS AuditsRestaurants generally conduct multiple cash transactions per day and, as a result, owners can easily understate their profits. This scenario, in combination with a sole proprietorship or partnership structure, may increase the chances of the IRS auditing your restaurant. As some background, the U.S. Treasury department in 2010 requested more stringent IRS audit measures because they recognized the high propensity of sole proprietors to underreport income on their taxes.This definitely does not mean LLCs are invulnerable to random audits by the IRS. However, the propensity to underreport is not as high relative to sole proprietorships or partnerships.

6. Financing / LoansAll things equal, forming an LLC can offer your business a higher chance of obtaining financing and loans versus a sole proprietorship or partnership. Since a sole proprietorship and a partnership are not separate legal entities, financial institutions and other investors can usually use only personal credit information when making lending decisions.On the other hand, an LLC is a separate legal entity and would have its own credit rating in the same way that individuals have credit scores. Thus, if you file as an LLC, potential lenders will likely consider business credit information in alternative to, or in addition to, personal credit information. This can potentially benefit your restaurant if you plan to expand, remodel, purchase new equipment, or implement other tasks that require additional financing / loans.