You’ve decided to start a business. Congratulations! Now all you need to do is serve your customers and begin raking in the profits, right? Think again, because becoming a business owner entails numerous responsibilities and decisions. One of your first tasks is deciding which type of business structure you want for your new company.
Will you do business as a sole proprietor, a limited liability company (LLC), an S-corporation or a C-corporation? The entity you select controls the way you file taxes, impacts the amount of personal risk that is involved and can even affect your long-term profit potential. To choose the structure that will best serve your needs, it helps to understand a bit about the different entities and how they work.
Becoming a sole proprietor is the simplest approach and doesn’t require any organization filings with the government. You’ll be paid directly by customers; all the income you earn is subject to self-employment taxes and you’ll report your income as part of your personal tax return, using Schedule C. Unless your income is quite low, you’ll need to pay estimated taxes on a quarterly basis.
As a sole proprietor, you and the business are fully entwined and inseparable from a legal perspective. This means if someone sues you or your company, the assets of both are at stake in any legal battle. However, you can apply for a separate Employer Identification Number (EIN) if you choose, which allows you to avoid sharing your social security number with customers.
An LLC provides more legal protection for the business owner’s personal assets, as it is a legally separate entity that must be registered with your state and renewed annually. Most LLC owners will want to apply for an EIN. Like a sole proprietor, you’ll report all business income on Schedule C with your personal income tax return and pay self-employment taxes, as well as quarterly estimated tax payments. Tax returns can be complex if your LLC does business in multiple states.
S- and C-Corporations
A fully incorporated business is legally separate from its owner(s) and must be organized and registered, with annual filings for corporate continuation. These entities must maintain annual corporate governance documentation, which for C-corps includes the minutes of required annual stockholder meetings. Corporations always utilize EINs. Since corporations must pay wages to employees (including owners or stockholders), income taxes can be paid through withholdings and the required payroll tax return filings.
Some S-corp profits may not be subject to self-employment taxes if the stockholder receives a profit distribution. C-corps have the benefit that they can deduct the cost of certain stockholder fringe benefits from their taxable income. On the other hand, C-corps face the potential for double taxation of profits. For both types of corporations, clear rules regarding multi-state income tax make compliance more straightforward than with an LLC.
Choosing the optimal entity structure for your business requires an analysis of numerous factors, including the type and volume of business that your company will perform as well as its potential for expansion into multiple states. In some cases, your business could “outgrow” the utility of its initial entity structure and benefit from conversion to a different entity type.
Often, though, business owners can avoid the cost and difficulty of changing entity structures by consulting with a knowledgeable expert at the outset. If you’d like to learn more about which type of entity might be right for your new business, please contact the experienced business advisors at Halt, Buzas & Powell.