One of the first decisions that business owners are tasked with is deciding how to structure their business. How much capital you have, how risky your business model is, whether or not you are looking for investors, and lastly the amount of revenue your business is generating are all factors when deciding. The four main entity types to choose from are Sole Proprietorship, LLC, C-Corporation, and S-Corp.
Sole Proprietorship
This is the easiest to start. You assume all of the businesses liabilities. There is no personal protection. You’ll report income on your own 1040 tax return on a “schedule c”. Unless you want to do business under a name other than what’s on your birth certificate, you don’t have to file any paperwork at all to start a sole proprietorship. All you have to do is start collecting money.
LLC
This is just as easy to operate as a sole proprietorship, but limits your liability. An LLC is a ‘disregarded entity’. You can pay yourself by writing checks from the business to your personal account and there is less paperwork involved but there is still a layer of personal protection. You do not assume all the businesses liabilities personally so long as you’re signing contracts for company and not comingling funds. Tax returns are still done on a schedule C.
C-Corporation
This is by far the most complicated to set up. There’s a lot of paperwork involved and you’ll be obligated to have periodic meetings (even if you’re the only one in the company) and keep minutes of those meetings. You will also have to set up payroll to pay yourself or have dividend payments be ‘double taxed’. The corporation will pay tax on its income and if you issue a dividend to yourself there’s also a capital gains tax that you’ll pay.
With all of these issues you may be asking yourself why anyone would want to create a C-Corp. The answer is that it’s incredibly easy to raise funds with a C-Corp if you’re going to seek investors. You can issue stock in exchange for capital. You can then transfer these stocks or issue stocks as payments for things.
A C-Corp also offers the greatest amount of protection. It’s very difficult to ‘pierce the corporate veil’ so long as you’re continuing to file the necessary paperwork, keep your business and personal finances separate, and don’t commit any crimes.
S-Corp
You cannot start an S-Corp. Instead, you create an LLC or a C-Corp and file paperwork with the IRS to elect to receive S-Corp tax treatment. It’s just a tax specification. There are subtle differences between a C-Corp and an S-Corp but the main one is that an S-Corp passes on taxes onto the shareholders just like an LLC. Rather than issuing dividends you can issue “distributions”.
If you’re starting to make more than $60k or so in revenue per year, an S-Corp is a great way to save money on your tax bill. Rather than paying self-employment tax on all your earnings, you can pay social security and Medicaid taxes on a “reasonable wage” and take the rest as a distribution which only requires you to pay capital gains tax.
You’ll want to consult with a professional and make sure what you think is ‘reasonable’ is.
Which one is right for you
If you’re just starting out, have little starting capital, and are not engaged in high-risk activities a sole-proprietorship is probably your best bet until you can afford to register an LLC. If your business is making less than 50-60k of profit per year, a simple LLC is probably your best choice. With both options, filing taxes and other administrative tasks are simple enough that you could do them yourself.
If your business is starting to make more profit and you’re wanting to save on taxes, an S-corp is likely the best way to go. You’ll want to consult with a professional in setting it up, maintaining accurate records of the capital accounts, and filing taxes. All of this adds to the cost of owning an S-corp, but when done properly you should be saving enough in taxes to justify the added expense.
I would not recommend starting a C-corp unless you plan to seek out investors and possibly go public with your company.