If you were an “entity” what would you be, and why?
Not exactly something you, as a business owner, enjoy contemplating is it? But it is a decision that must be made when you are setting up a business. The options are Sole Proprietorship/partnership, LLC (Limited Liability Company), C-Corporation, or S-Corporation. The decision you make has many implications. Start by asking yourself some questions:
- How much personal liability are you willing to risk?
- What do you anticipate as the income cycle over the next few years?
- Do you think you’ll need to raise money in the form of investors or loans?
- Do you have resources to help you with payroll, taxes and legal matters?
- What are your ambitions to grow your business?
It almost seems like the deep questions of the universe, doesn’t it? But to truly figure your right fit, the first step is to understand where these questions fit in to the different structures.
A Sole Proprietorship is basically an individual business owner. This is the simplest and cheapest form of operation. All the ins and outs of the money just flow through to the owner’s personal tax returns on a Schedule C. There’s no true requirement to maintain separate business records, but of course it’s recommended. As the business owner, you are then subject to paying self employment tax on the earnings.
Doesn’t sound so bad right? The primary cons to this structure are:
- Liability – If you are sued or creditors come after your business, then you as the owner and all your personal assets are at risk.
- Tax savings – Generally speaking, there is an income threshold that usually makes it tax-wise to switch to a corporation.
- Business Growth – If there comes a time when you are hoping to get a loan or investor backing, its harder to prove your the financial worth and credibility of your business with intermixing of personal and business assets.
LLC or Limited Liability Company
An LLC or Limited Liability Company is similar to Sole Proprietorship as the income flows into your personal tax return but it provides personal liability protection. The downside is that there are state filing fees, some accounting complexities, and legal services that you should obtain to properly elect this entity. In some cases LLC’s have even more legal/accounting complexities for compliance than corporations. Also, since the entire profit is subject to the self-employment tax, it restricts your ability to defer income to later years and avoid higher tax brackets (as with the Sole Proprietorship).
As a Corporation your business is its own “legal entity.” Business income, for a C Corporation, is taxed at the corporate level and the money taken out of the corporation by you as a dividend is taxed.
Primary pros and cons to being a corporation are:
- Only corporate assets are exposed to financial liability. (Your personal assets are protected.)
- A corporation may be given more credibility in the market place and additional capital may be more easily secured.
- State filing requirements to complete annual documents, pay annual fees, and hold officer meetings.
- Detailed record keeping in order to be in compliance with Corporation laws.
- C -Corporations endure “double taxation.” A corporate income tax on profit in addition to the personal income tax that you as owners have to pay on your dividends must taken into account before making the choice to be a known as a corporation.
Another election could be made to be what’s known as a S-Corporation (vs the normal C-Corporation described above). The biggest advantage is that as an owner, money can be taken out of the business as dividends and there is no corporate income tax so there’s no double taxation. There are limitations on types and number of partners as an S-Corp though. Also, once this election is made, no change in entity form can be made for 5 years, so long-term planning is crucial.
Good news: it doesn’t have to be complicated if you have the right information. Bad news: There’s no one right answer for every situation.
As you can see, there are huge implications from this decision and we are more than happy to help you sift through the information and point you in the right direction. Contact us today! We promise to make it as painless as possible so you can get back to doing what you do best…making money!