One of the most common questions I receive from new startup clients is how to organize their business. There is no simple answer to that question as it depends on the types of business you are planning to open, the size of the operation, how much revenue you project, the degree of liability and other factors.
Lets consider the three most common types:
Sole Proprietorship or Simple Partnership - For the purposes of taxation and legal status the government draws no distinction between you and your sole proprietorship business. All of the income you derive from the business is reported in your taxes as personal income. In addition you will be required to pay self employment taxes on the income you receive up to the statutory limit. On the social security component it’s 12.4% as of this writing for earnings up to $ 127,200. The Medicare component is 2.9% and there is no limit on that. Self employment taxes are like payroll taxes that you pay if you are, or have been employed anywhere, however since you are now the employer and the employee you have to pay the entire amount which combined as of this writing is 15.3% (12.4% + 2.9%). A sole proprietorship doesn’t require any additional filings with most states, however your city and county will probably require you to get a business license an occupational certificate, and in addition if you are using a name other than you own, a DBA (doing business as) or fictitious name filing. The DBAs or Fictitious names are registered so as to keep multiple companies from using the same name. Under a Sole Prop, you are liability for any and all actions of the company, since you and the company are indistinguishable.
Limited Liability Corporation – Under an LLC a separate entity is created which acts like a corporation in that you gain a certain amount of liability protection on your personal assets. For instance if your LLC owns a vehicle registered in the name of the LLC and it’s involved in an accident, the LLC not you, is responsible for any damages. Of course it goes without saying that you should have sufficient insurance. However, as the name implies your liability is limited by the assets of the company not your personal assets. It should be pointed out however that if you have personally involved yourself in a situation that resulted in a claim or a suit; it is possible that you could still have personal exposure. So think of an LLC as providing a legal firewall, but don’t assume that the firewall is unpenatratable. Like the sole prop the income from the business is passively reported onto your personal income taxes.
Sub Chapter (S) Corporation – Like an LLC, a Sub S creates a separate entity and affords you some protection from any damages that can arise from the actions of the business. However there are additional recording keeping requirements with a Sub S including annual corporate filings with your state, recording of the annual meeting of the board of directors and the appointment or renewal of officers. It’s also common practice to establish bylaws. These records must be kept up to date. Should an incident arise where you have to prove that the corporation exists, if records have not been kept, the existence of the corporation could be legally challenged. There is another important difference regarding taxation. With a Sub S corporation the owner(s) may pay themselves what the IRS calls a “reasonable salary” for the work that they do. The self employment (payroll) taxes are only accessed on the salary that the officers receive, not the entire net profit of the company, thus if you suspect you business will be making in excess of what a reasonable salary might be, you may want to consider organizing as a Sub S Corporation.
Corporations are organized and granted at the state level. Each state has different requirements. For simplicity, I commonly refer clients to an online organization such Standard Legal for organizing a Sub S Corp or an LLC. They can prepare all of the appropriate documents for you including templates for your annual records, file the documents with your state and give you instructions and help on keeping current on all your records and reports. You will be required to pay any filing fees in addition to what the service provider charges. Fees average around $100 for a Sub (S) Corp or LLC.
With any business type you should consider getting an employee identification number (EIN) you can get this by contact the Internal Revenue Service.