When you start a new business, one of the first decisions you’ll have to make is how to structure your company. This choice can be critical to the future health of your business. Taking time up front to consider the pros and cons of each possible structure will likely save you many headaches in the future. In certain cases, it can mean the difference between your business’s success and its failure.
- Easy to form — Sole Proprietorship is the easiest and least expensive structure. A person is essentially a walking, talking sole proprietorship in waiting. You don’t file paperwork, tell any government agency, nothing. All you need to do is sell something—a product, a service, anything—and boom…suddenly you’re a sole proprietor. Aside from any required business licenses, a Sole Proprietorship requires no paperwork and no filing fees.
- Decision making — As indicated by the name, you are the sole decision-maker. You run your business the way you want to run your business. You don’t have to ask anybody for permission.
- Taxes — The IRS doesn’t view your Sole Proprietorship as a separate tax entity, so there’s no special or additional tax paperwork. You file your taxes on the same 1040 form as any other individual.
- Liability — The lack of separation between you and your business leaves you entirely liable for all debts and legal decisions. You are even responsible for the actions of your employees.
- Funding — Sole Proprietorships lack a specific structure for fundraising. You have no stock to sell, no set percentages to offer, and banks can be reluctant to offer loans to sole proprietors.
Limited Liability Company
- Liability — The greatest benefit of an LLC is its liability protection. Without a lot of work in the courtroom, personal creditors cannot seize your business assets, and if your business is involved in a lawsuit or judgment, your personal assets cannot be seized.
- Paperwork — Compared to corporations, LLCs have far less paperwork. They are less formal and have fewer requirements regarding resolutions and meetings.
- Taxes — Profit flows through the company and straight to the members. There are no separate corporate taxes, and no additional tax documents since your earnings are reported on your personal tax return.
- Self-Employment Tax — Taxation is still simpler in an LLC than a corporation, LLC members must pay non-deductible self-employment taxes (your share of Social Security and Medicare).
- Treatment of income – Regardless of whether a member’s share of the profits are distributed to him or her, that share of profits represents taxable income.
- No salary: LLC members cannot pay themselves wages.
- Liability — Like LLCs, C-corps are entities separate from their owners. This separation creates liability protection. Although this asset protection is not bulletproof, business creditors cannot easily seize your personal assets to pay bad debt, and your personal assets will most likely be safe from lawsuits against the corporation.
- Fundraising — C-corps benefit from multiple avenues through which to raise money. Stock can be sold and many investors tend to feel more secure investing in corporations as they are established business structures with a long legal history.
- Employees — C-corporations can offer a range of benefits to employees that generally make working for the corporation more attractive than working for other business structures.
- Keep money in the corporation — Although all corporations will pay their net income tax on net profits, those profits can be kept in the company without paying additional taxes on that money, which is attractive to those who want to build capital or invest in their company.
- Double-Taxation — If a C-corp issues dividends, that money that is issued to shareholders have been taxed twice. First, through paying corporate income taxes. Second, shareholders must pay individual income taxes on dividends.
- Formality: C-corps’ formality, with boards of directors, meetings, annual reports, and sometimes byzantine federal and state requirements can make them slow and cumbersome to operate. C-corps must file more paperwork than any other type of business structure.
- Versatility — S-corps are kind of like a hybrid between the C-corp and the LLC. They are taxed as a pass-through entity like an LLC, but S-corp members are required to pay themselves what the IRS calls “reasonable” wages. Both LLCs and C-corps can elect to be taxed as an S-corp.
- Taxation — S-corp shareholders who are also employees pay employment tax only on their wages, a subtle but important difference from LLC members, who have to pay employment tax on the net income of the business. Remaining income is paid to owner/employees as a distribution, but the member isn’t required to pay the 15.3% self-employment tax.
- Shareholder limitations — S-corps are limited to 100 shareholders or less. All shareholders must be US citizens; no corporations or partnerships. Only one class of shares can be issued.
- IRS attention—With an S-corp, you may run the risk of greater scrutiny from the IRS at tax time, as some business owners have tried to pay themselves low wages and take big dividend distributions to save money on taxes. That’s why, if you do elect to be taxed as an S-corp, you’ll want to document your reasoning behind what you’ve decided to pay yourself as a wage.
View the full original article here.