Sole proprietor. LLC. Corporations. Each business entity has advantages and drawbacks.
Knowing the differences between them is important when you are deciding upon what business structure makes the most sense. There are legal and tax implications, paperwork and fees that may need to be filed and paid, and you want to keep an eye to the future needs your business might have. There are many types of business entities, and in this blog we will discuss a few.
Sole Proprietorship: This is an unincorporated business with a single owner (or it can be jointly owned by a married couple). You don’t need to file any paperwork, but you will want to know if you need any business permits or licenses. As a sole proprietor, your taxes are fairly easy, most losses can be deducted by using a Schedule C-Profit or Loss From Business attached to your personal income tax return.
While a sole proprietorship is by far the easiest business structure to set up, you have to be careful about your personal liability since your personal and business finances overlap. If you are sued, you run the risk of having your personal assets taken as well. It can also make it more difficult to obtain business loans or find investors. So, at some point you may want to consider converting your business into a corporation or LLC.
Unlike a sole proprietorship, a corporation is considered a separate entity apart from its owners and, as such, it has its own legal rights and can sue, be sued, own and sell property, and sell ownership in the company in the form of stocks. There are several types of corporations but we will discuss just two of them below.
C-Corporation: If a business is run as a C-corp, the owners/shareholders do not have any personal liability for the business’s finances, unlike under a sole proprietorship. C-corps also are eligible for more tax deductions than other type of business and owners will pay lower self-employment taxes. A C-corp can also raise money by selling stock.
However, when structured as a C-corp, there are some things to consider. Each state has differing filing regulations and fees which can range from $100 to $500. Corporations also have certain formal rules they operate under. There must be regular board and shareholder meetings, with minutes kept, and bylaws are created. From a tax perspective, while there are more deductions corporations can take and lower self-employment taxes, if as an owner you are receiving dividends, there is the issue of double taxation. This isn’t a problem if you prefer to invest profits back into the company rather than distribute dividends, but it is something to consider.
S-Corporation: An S-corp has the same limited liability protection that a C-corp has, but for tax purposes it is considered a pass-through entity. Rather than being taxed on a corporate level, the profits and losses pass through to the personal tax returns of the owners. So, in this way, double taxation is avoided.
Like C-corps, setting up an S-corp has fees associated when it is registered. They are also held to the same rules such as corporate meetings and creating bylaws. In addition, if the company would like to offer stock, there are more limitations on offering them as an S-corp than a C-corp.
Limited Liability Company (LLC): The final type of entity we’ll discuss in this blog is the LLC. This has some of the positive features of corporations such as limited liability protections for the owners. And because there are fewer requirements to follow, in some ways it functions like a sole proprietorship. One of the major advantages is that you can choose how you want your LLC to be taxed: either as a corporation or a pass-through entity.
An LLC does require registration with the state and there are fees associated with that. In the event that the LLC is sued, there is a chance that the LLC structure won’t protect your personal assets, for example, if the courts are not able to clearly determine which financial transactions are business or personal, or if it’s proven the owner acted fraudulently, personal assets can be put at risk.
There is not a single best choice for all businesses. As your business evolves and grows, the type of entity you choose may change. Working with a trusted advisor who can give you advice specific to your business is the smart choice.