“When most investors, including the pros, all agree on something, they’re usually wrong.”
What type of business structure should you have? Should you incorporate, form an LLC or just stay the way you are, without formal structure?
The question of business structure is complex. At the base of it you are deciding on what legal form you want your business to take. This legal form will dictate many things, most importantly, it will dictate your liability limits and how you are taxed.
There are several business structures for you to choose from. The most popular are:
- The Sole Proprietorship – the simplest form of business. All profit is treated as ordinary income for tax purposes and you have no liability protection.
- The Partnership – simply a sole proprietorship with two or more people. Partnerships generally have legally binding agreements between the participants. Profits are treated as ordinary income to the partners and there is no limit to the liability of those partners.
- The LLC – a separate legal entity with tax benefits and protection against liability.
- The Corporation – a separate legal entity where business income and wages are taxed.
LLC – Limited Liability Corporation
According to the IRS, the purpose of an LLC is to ‘provide the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.’ As a pass-through entity, all profits and losses pass through the entity to the LLC owners.
The LLC is one of the preferred business structures today. Once formed, the LLC exists as a separate legal entity. It exists under the law and has its own Employer Identification Number (EIN). The EIN is valuable. With it you can open bank accounts, set up business relations and report your earnings to the government.
The LLC provides you with a limited personal liability for corporate actions – generally limited to the amount of your investment. The LLC also avoids double-taxation, which happens you form your business as a corporation.
Setting up an LLC
The cost to set up your LLC will vary by state. You should use a service provider to do the leg work for you. Depending on your state, the process can be tedious and filled with pitfalls.
There are several on-line providers you can use which all streamline the process of applying with easy to use software, filing services and support along the way.
MyCorporation – Online order forms guide you step-by-step through the process making it fast and easy (with experts available to answer your questions). This site also has some great ebook downloads and other helpful tutorials. Starts at $69
Legal Zoom – Form your LLC in 3 simple steps. Starts at $99
RocketLawyer – Checks your name, files your paperwork and follows up with your state. There are specialists to answer your questions and legal help after you incorporate. Rocketlawyer gives you access to ask questions to real lawyers. There is a free trial, and then a monthly fee of $39.95
Go to your homestate’s secretary of state’s website to file your application online. It’s not recommended as the paperwork is complicated for novices.
LLC with S-Corporation taxation
S-Corporation shareholders are not subject to self-employment taxes (active LLC owners are). These taxes, which add up to more than 15% of your income, are used to pay your Social Security and Medicare taxes.
Operating as an S-Corporation may be wise for several reasons:
Forming an S-Corporation generally allows you to pass business losses through to your personal income tax return, where you can use it to offset any income that you (and your spouse, if you’re married) have from other sources.
When you sell your S-Corporation, your taxable gain on the sale of the business can be less than it would have been had you operated the business as a regular corporation. continued >>
An S-Corporation is a regular corporation that has elected “S-Corporation” tax status. Forming an S-Corporation lets you enjoy the limited liability of a corporate shareholder but pay income taxes as if you were a sole proprietor or a partner.In a regular corporation (also known as a C Corporation), the company itself is taxed on business pro?ts. The owners pay individual income tax only on money they receive from the corporation as salary, bonuses, or dividends.
By contrast, in an S-Corporation, all business pro?ts “pass through” to the owners, who report them on their personal tax returns (as in sole proprietorships, partnerships, and LLCs). The S-Corporation itself does not pay any income tax, although an S-Corporation with more than one owner must ?le an informational tax return like a partnership or LLC, to report each shareholder’s portion of the corporate income.
Most states follow the federal pattern when taxing S-Corporations: They don’t impose a corporate tax, choosing instead to tax the business’s pro?ts on the shareholders’ personal tax returns. About half a dozen states, however, tax an S-Corporation like a regular corporation. The tax division of your state treasury department can tell you how S-Corporations are taxed in your state.
Visit mycorporation.com for more information
A corporate business structure is not just for the big boys with millions in revenues and hundreds of employees. Plenty of small businesses are formed as corporations and you can do this too.
Like the LLC, the corporation is a separate legal entity. It’s ownership is done through the issuance of stock (you can have 100% of the shares if it is only you in business). Generally, the stock holder liability, in the event of a law suit, is limited to the amount of that stockholder’s investment.
Be aware that your income from the corporation is taxed twice. It is taxed once when it is earned by the corporation and again when the corporation pays it to you. This is where the LLC really shines. With an LLC, income “passes through” the corporate level and is only taxed when it is paid to you.
Corporations are complicated. That is putting it mildly. Unless you have a compelling reason to form your business as a corporation, a reason suggested by a lawyer or an accountant, you are better off being an LLC.
*Disclaimer: I’m not a legal expert, attorney or accountant. I’ve given suggestions based on my experience and research. All business situations are different and some may require advice from a licensed attorney or accountant.