Congratulations! You have decided to launch your own business. Before you get started, you need to define your corporate structure. Everyone’s situation is unique, which means your business entity will need to reflect your circumstances. Here is an overview of the options that are available to you.
This is the simplest business entity, which means you can get to work immediately. You don’t need a tax ID (EIN) or business registration. Also, your income and expenses are reported on your personal tax return. It is recommended that you open a separate bank account to keep company funds from commingling with your personal finances.
One disadvantage of a sole proprietorship is taxation. You will be subject to a self-employment tax rate of 15.3 percent on the ordinary net income of your business. This includes product sales, commissions and short-term income. As a sole proprietor, you are personally liable for all aspects of the business.
Limited Liability Corporation (LLC)
An LLC allows you to establish an official name for your business. It also offers personal protection from the operations of the business. The LLC can be run as a sole entity or a partnership.
LLCs don’t save you money on taxes. As a matter of fact, they require additional expenses, such as filing fees and additional expenses. However, the protections that these corporate entities offer may outweigh the costs. For instance, LLCs are ideal for rental properties, since it protects the owners from liabilities from tenants, contractors and guests.
Most small businesses prefer an S corp because its members aren’t personally responsible for corporate debts and liabilities. Also, the owner’s share of the company’s income is not subject to the self-employment tax.
This corporate structure is meant for small businesses, so there is a limit of 100 shareholders. One advantage is that it isn’t subject to corporate tax. Therefore, shareholders avoid paying this tax on their net income. Instead, they can take a salary through a W-2, which allows them to report some profits as net income.
A C corp is a taxable entity. This means that the company is taxed on its income, which is different from the other entities. One advantage to this approach is to keep a portion of income within the company. If it is split between the shareholders and the corporation, the tax rate can be lower. The disadvantage of this approach occurs when you want to distribute profits of the corporation at a later date. Those earnings are then taxed as dividends.
Your corporate structure is an important element of your business. Make sure you choose the entity that addresses your needs so you can focus on bringing your new product to market.