There are many decisions you need to make when starting a business. One such decision is deciding the business structure for your business. To select the right structure, you must understand what it is and how it can benefit your business.
A business structure is a legal category that defines how you and your business pay taxes. The benefits include the following:
– Tax benefits,
– Separation of personal and business assets, and
– Legitimizing your “gig” into a business.
Most businesses start as a sole proprietorship. As a sole proprietorship, you can do the following:
– Open a bank account
– Take a lease
– Open utility accounts
– Open a merchant account
– Pay taxes
The most critical factor to consider is that you and the business are the same entity. There are no legal protections. Your personal and business assets are not separate. You pay more in taxes since you pay Social Security and Medicare tax as the employer AND employee.
We recommend the sole proprietorship structure if all the following apply:
1. You do not plan to scale your business any time soon
2. You do not plan to hire employees, or
3. The business is a side “gig”
To apply as a sole proprietorship, register your business as a DBA (Doing Business As) at your county or city office. You will also need to get an EIN (Employers Identification Number). You can get an EIN in less than five minutes by going to the IRS website or sending form SS4 to the IRS via fax or mail.
LLP or LLC
The LLP structure is typical for a law office, doctors, architects, investment funds or any professional that requires state licensing. For this article, we will focus only on the Limited Liability Company (LLC) structure.
The last thing you want to think about when starting a business is the possibility of failure. The LLC structure protects your personal interest by drawing a line between your personal and business assets. It limits your personal liability in the event of a loss.
There are also tax benefits as an LLC. Business taxes are not as simple as personal taxes. You will need the expertise of a tax professional (not a tax preparer) to guide you through the process.
We recommend the LLC structure if either of the following apply:
– You do not plan to raise capital from investors or go public any time soon,
– You have more than one owner that will share the profit or losses on their personal tax returns.
The corporation structure is more complicated than other structures. It requires more paperwork, formality and in some cases, double taxation.
A small business should become a corporation only if the business plans to raise capital from outside investors. Raising capital means you will have shareholders and a board of directors.
There are two types of corporations: S-Corp and C-Corp.
The S-Corp has shareholders, not owners, who are responsible for reporting the profits or losses on their personal tax return. As a shareholder, you benefit from the following:
– Your personal assets are protected,
– Your salary is an expense for your business, and
– You avoid “double taxation”
The C-Corporation is its own entity, operated by a management team. In some cases, it is overseen by a board of directors who can also be shareholders or investors of your company. IOOGO Inc is a C-Corp because we raised capital from angel and institutional investors. The company pays its own taxes. The shareholders do not report anything on their tax return on behalf of the company. All salaries, bonuses and other compensations are tax-deductible for the business. As an owner that work for the business, you do not pay self-employment taxes. The corporation pays its part, and you pay your part, like in any job.
To form an LLC or Corporation, you must file articles of incorporation with your Secretary of State. Incorporating will give you protection in your state only. You also need to file the necessary documents with the IRS to elect the proper tax treatment for your business.
We highlighted some of the key reasons to register or incorporate your business, but we did not cover all factors. Feel free to reach out to us if you need help planning or developing your own business.