Which business entity is right for you?
Taking the plunge and starting a business?
Well, there are many decisions that you will need to make along this journey.
One of the most important is choosing the business entity that is right for you. Choosing the right business structure for your company affects how you will run your business, your liabilities, taxes, and could potentially have impacts on your personal assets.
Each entity has its set of pros and cons.
Let’s review them below.
Sole Proprietor is the simplest and most common form of legal entity. In a sole proprietorship, you and your business are the same, and you are responsible for your company’s profits and debts. You have no partner(s), and complete control of your business.
Once you decide to start a business, you can begin right away. No need to file paperwork with your state or open a separate bank account. You may need to register a fictitious business name with your county, but that’s about it.
Sole proprietorship does not offer the separation or protection of your personal and company assets. You are held personally liable for all financial obligations, and this could become an issue as your business grows, and your potential liabilities grow with it.
Limited Liability Company
A limited liability company (LLC) is a legal structure formed under state law. It is a favorite of many and considered a hybrid form of partnership because you receive benefits of both a corporation and partnership.
It is easy to form and operate and has tax advantages such that profits and loss are passed through to you without prior taxation of the business. You are also protected from personal liability if it can be proven that you have not acted in an illegal manner or conducted unethical business practices.
Higher start-up fees than a sole proprietor since you will need to file with the state. Also, there are annual fees to consider. You will need to open a separate bank account to keep your personal business separate from your company, and these accounts tend to have higher fees.
Filing as an S Corp while an LLC
You can choose to have your limited liability company (LLC) taxed as an S corporation by filing an election with the IRS. Once this is completed, your LLC will be the same as a corporation and you will files taxes as such.
You get the limited liability that comes with an LLC, and the tax benefits of an S corporation. An S corporation is a pass-through structure, meaning income and losses are reported on your personal tax returns, so you save corporate level taxes.
This option also allows you to make as much money from your business as possible. In addition to paying yourself a salary as an employee, you can also receive profit distributions as a shareholder which are not subject to payroll taxes.
Here’s how it works, let’s say you receive $150,000 as a sole proprietor, you will have to pay taxes on the entire amount. However, in an S Corp, you can pay yourself a salary of $75,000 and then receive a profit distribution of $75,000. You will owe payroll taxes only on the former.
There are formation and ongoing fees to consider. Also, there is very close IRS scrutiny with this selection so make sure your bookkeeping is up to date and accurate.
A corporation is an entity separate from you. It has its own legal rights, independent of you and your partners. A corporation can sue, be sued, own and sell property, and sell the rights of ownership in the form of stocks.
There are different types of corporations:
- S corporations – generally do not pay any income taxes; income or losses are divided and passed through shareholders, then income or loss is reported on individual tax returns
- C corporations – taxed as separate entities, so the corporation pay state and federal taxes
- B corporations – a for-profit entity that makes a positive impact on society
- Nonprofit corporations – qualifies for certain tax-exemption due to benefiting the public and other specific individuals and groups
- Closed corporations – due to the small number of shareholders, it is exempt from many rules ordinarily governing corporations, not publicly traded, and benefit from limited liability protection
Due to the limited liability that comes with corporations, your personal assets are safe from creditors in case of debts; you can raise money in the form of stocks, and make many deductions for business expenses.
The most significant disadvantage of a corporation comes in the form of taxation. Some corporations like C Corps are subject to “double taxation.” C corporations pay tax on profits first at the entity level, and then you pay taxes at the individual level on profits received as dividends. It is also more complicated and expensive to set up, unlike sole proprietor and LLC. It does require more paperwork and regulation compliance.
When selecting a legal entity consider the tax implications, legal liability, start-up fees, and your future needs. This is just an overview of your options. We recommend you speak with a qualified professional to help you form an entity that best suits your situation so that you can avoid issues down the road.