Starting a small business isn’t all fun and games. Yes, you get to flex your creative muscles by coming up with a name or designing a logo, but you also have to make important decisions. That includes choosing a business structure.
Will you be a sole proprietor? An LLC? A C-Corp? How much paperwork will you need to file? What are the tax liabilities and loopholes for each? Do you need an attorney? Can you go it alone?
If you’re staring at your screen in abject horror as you consider scrapping your entire plan and moving to Bermuda, don’t panic! We have the information you need on different business structures, as well as the benefits and drawbacks of each.
A sole proprietorship is just another way of saying “me, myself and I.” This business structure means it’s your small business — no partners, no incorporating, no nothing.
For many small business owners, a sole proprietorship is an attractive option because it’s simple to set up. There’s minimal paperwork, and in fact, if you start up a business, you’re already a sole proprietor by default.
As a sole proprietor, your business income and expenses are listed on your own personal income tax return. You’ll also file a Schedule C and will still be required to calculate and pay your self-employment taxes. But compared to filing business tax returns, this is a snap.
It’s not all smooth sailing. As a sole proprietor, you are your business, and your business is you. This means if disaster strikes, your personal assets are on the line. If the business goes bankrupt or faces a lawsuit, your home, car and other personal effects become fair game to help pay the debt.
Many banks aren’t too keen to loan to sole proprietors, either, so getting funds you need when you need them may be difficult.
Are you opening your small business with a family member, your college buddy or the co-creator of your product or service? A partnership may be right for you. In this structure, you run your business as a team, with each partner being liable for business obligations and debts.
Partnerships offer pass-through taxation, which means profits and losses flow through to the individuals at tax time to avoid being taxed at the personal and the business level.
There are drawbacks here, too. As with a sole proprietorship, your personal assets aren’t protected. And because each partner has equal rights, you may find yourselves butting heads on major decisions — or worse, having a partner make major decisions without your consent!
For small business owners, an LLC (limited liability company) is the most popular choice, with more than 80% choosing this structure because of its flexibility.
An LLC is its own entity. The business itself is responsible for its own debts, which means all your personal assets are protected. Anyone can be named as an owner, and the profits of the business can be distributed the way you see fit, regardless of the stake someone has in your company.
LLCs are taxed the same as a sole proprietorship or partnership, affording you the luxury of that magical “pass-through” taxation we talked about earlier.
The downside of an LLC is that it’s more expensive to establish than a partnership, and it’s a bit harder to manage, since you’ll have to keep separate, detailed records.
C and S Corps
Corporations have many more rules than the above business structures. While both provide the liability protection that makes an LLC so attractive, corporations are expensive to establish and usually require an attorney’s help. You’ll need to establish a board of directors, draft bylaws, hold formal meetings and more.
C-corps are subject to double taxation — once at the corporate level, and again when dividends are paid out to their shareholders. However, if you opt to take a salary rather than dividends, it’s taxed only once — at the individual level — as long as your salary is considered “reasonable” by the IRS. (Who better to determine what reasonable means?)
S-corps are a bit laxer with their rules, offering pass-through taxation, but there are limits on the number of shareholders they can have, and are only allowed one stock classification.
The (Slightly Blurry) Bottom Line on Business Structures
Each business structure has both advantages and drawbacks. The (admittedly lofty) goal is to figure out what works best for your small business. Do your homework, talk to other small business owners and remember, your choice isn’t set in stone. You can always restructure if things aren’t working out.
Whether you’re a sole proprietor or the newest corporation on the block, Mischa Communications is here to help! Get in touch today and let us show you the Mischa difference.