A common question we get asked all the time is, when it comes to structuring my business from a legal standpoint and taxation standpoint, what should I do?
Here's the answer: It depends.
It depends on your situation. It depends on the type of company you have. It depends on your tax bracket. It depends on what type of growth you are looking to achieve over time. It just really depends on so many things.
For starters, a business can be structured as a partnership, a Limited Liability Corporation (LLC), S-Corporation (S-Corp), and C-Corporation (C-Corp).
As a small business take C-Corp and just get it out of your mind. A tiny percentage of businesses are actual C-Corps, and those are very, very, huge publicly traded companies that have unlimited shareholders and are taxed as a seperate entity. Think of companies like Microsoft, Bank of America, and GE. You are not a C-Corp, so we'll table that one.
Now that leaves us with Sole Proprietorship, S-Corp, General Partnership and LLC.
S-Corp is the lite version of th C-Corp. It offers the opportunity for attracting a limited number of investors, and limited liability protection as a C-Coprp. But unlike the C-Corp, you only file taxes annually and you are not subject to double taxation -- once as corporate income and once as dividend (shareholder) income. Again, not many small businesses take this route.
Sole Proprietorship meaning you own and operate your business alone and there is no legal distinction between the owner and the business. Essentially, all of the money that you would make as a sole proprietor is going to be put on your regular, personal, tax documents.
When you file your taxes at the end of the year and it asks you have you made any income outside of whatever your normal job is, you have to say yes. It is an unincorporated, non-legal entity so all debts incurred by the business also become personal debts.
This is a great place to start, but we do not encourage successful entrepreneurs to stay there: it is just too risky and does not allow for maximum business growth.
General Partnership is a business operation between two or more parties who share the management, profits and assumes liability for the partnership. It is the same as a sole proprietor, just more than one person.
80% to 90% of all small businesses incorporate as an LLC.
Most small businesses will go with an LLC. An LLC stands for Limited Liability Corporation that can be taxed two ways: as a "single member LLC", which means you own that all by yourself; or a "partnership LLC", which means you have more than one member.
If you are ready to take the next step of incorporation, you can choose any option listed above. But we highly recommend focusing small businesses on becoming an LLC.
80% to 90% of all small businesses go this route because it gives you protection as a business owner -- hence the name "limited liability". So if someone wants to sue you for messing up, they are not suing you personally. They are suing your company's assets: capital, equipment, and land assets, etc. In this scenario, your home or money is not at risk in a lawsuit.
Another reason small businesses opt for an LLC are the tax benefits. With an LLC, you can give yourself an income (or not), and you can dictate what income that is. You can even pay yourself and not have to pay any personal taxes on that.
But at the end of the year, you're now going to have to do a corporate tax return and a personal tax return. You will pay an accountant to do a corporate tax return for your business, and they will file that with the IRS.
C-Corps are for the large companies out there; a sole proprietorship or partnership offers no legal corporate distinctions or protections for entrepreneurs; and an LLC offers the legal protection and room for growth.
If you're in doubt about where to start with incorporating your business, start with an LLC.
Pro-tip: an LLC can become an S-Corp as the company grows which allows opportunity for selling equity and shareholding.